What’s the deal with inherited IRA’s?
When a person passes away with an individual retirement account (IRA), they often name individual beneficiaries to inherit the accounts directly from the custodian. However - unlike your own Roth IRA, Traditional / Rollover IRA, SEP IRA, etc - an inherited IRA comes with a different set of tax implications that you should be aware of both as a beneficiary and as you think through your own estate planning.
Prior to the SECURE Act, an inherited IRA had something called “stretch” benefits, which meant that you could take required minimum distribution over a certain period of time based on your life expectancy, with some exceptions.
Now, with the SECURE Act in place, unless an exception applies, you will generally have a 10-year window to distribute or empty out that account. Because of the lack of direction on these accounts, it was originally thought that you could time the distributions - meaning it didn’t matter which year you took them, as long as the account was empty within 10 years. This appeared to have opened up some tax planning opportunities, since the investments in the account continue to be tax deferred, but you must recognize the income for tax purposes in the year you distribute or receive funds from that account.
But, in 2022, the IRS proposed regulations that stated even though the distribution window has changed to 10-years (rather than stretch based on your age), you will still need to take required minimum distributions in the first 9 years based on your life expectancy. Then, on the 10th year anniversary, whatever remains in the inherited IRA needs to be withdrawn.
What are the exceptions to the 10-year
withdrawal rule?
Even with the update tax rules on the secure act, inherited IRA benefits can be stretched over the lifetime of the beneficiary under certain circumstances that include:
Transfer to spouse - if you are the surviving spouse or if you’ve named your spouse as the primary beneficiary of your IRA, then he/she can still stretch the benefits over his or her lifetime.
Transfer to minor child - if your minor child (not your grandchild) is named as beneficiary then the required minimum distribution window is expanded - on a side note, it is generally a bad idea to name a minor child as a beneficiary because of custodianship rules - from an estate planning standpoint, you should name your trust as the beneficiary rather than you minor child and just make sure it has secure act compliant language inside the trust document.
Transfer to someone less than 10 years younger than you - for example, some people will name their sibling or friend who is close to their age as a contingent beneficiary if married without kids (or primary beneficiary if you have no kids and are not married).
Disabled beneficiary - certain people who qualify as disabled or chronically ill under Internal Revenue Code rules could also have an expanded time window to make withdrawals from the account.
Given the complex nature of retirement accounts funded with pre-tax dollars (generally traditional IRAs or traditional 401k’s) and the fact that such accounts do not get a stepped up basis upon your death (which means from an estate planning standpoint your traditional IRA is actually worse off tax-wise than a taxable brokerage account), you may want to consider spending down your traditional retirement accounts prior to other non-traditional retirement accounts. If that last part went over your head, give me a call and I’d be happy to explain further.
Need help with your estate planning?
If you would like to review or update your estate plan, then give me a call at 781 202 6368 (MA), 603 836 4166 (NH), email jlento@perennialtrust.com, or click here to schedule your free personal consultation.
I’m always happy to help!
Joseph M. Lento, J.D.
Your Local Estate Planning Attorney
www.PerennialEstatePlanning.com
Massachusetts Office:
477 Main Street
Stoneham, MA 02180
New Hampshire Office:
91 Middle Street
Manchester, NH 03101
