Inheriting an IRA can come with more decisions than you might expect. When do you need to take distributions? Does the account have to be emptied within 10 years? And how might withdrawals affect your taxes?
The answers depend on several factors, including your relationship to the original account owner, the type of IRA you inherited, and whether the owner had reached the point when required minimum distributions (RMDs) were required to begin.
Changes introduced by the SECURE Act significantly altered the rules for inherited retirement accounts, particularly for non-spouse beneficiaries. Final IRS regulations provided additional guidance on how the 10-year rule and annual RMD requirements work.
Here’s what beneficiaries should understand.
How the SECURE Act Changed Inherited IRAs
Before the SECURE Act, many non-spouse beneficiaries could generally take distributions from an inherited IRA over their life expectancy. This approach was commonly known as a “stretch IRA” because it could extend distributions, and potentially tax-deferred growth, over several decades.
For deaths occurring after 2019, the SECURE Act generally replaced that approach with a 10-year distribution rule for many non-spouse beneficiaries.
Under the 10-year rule, the inherited account generally must be emptied by December 31 of the tenth year following the original account owner’s death.
However, the 10-year rule isn’t as simple as waiting 10 years and withdrawing the entire balance. Some beneficiaries may also have to take annual distributions during that period.
Does the 10-Year Rule Require Annual RMDs?
Whether annual RMDs are required during the 10-year period generally depends on whether the original account owner died before or after their required beginning date, or RBD.
The required beginning date is the point when the original owner was required to begin taking RMDs.
For a designated beneficiary who isn’t an eligible designated beneficiary:
- If the owner died before their required beginning date: The account generally must be emptied by the end of the tenth year, but annual distributions generally aren’t required during years one through nine.
- If the owner died on or after their required beginning date: The beneficiary generally must take annual RMDs during the 10-year period and fully distribute the account by the end of year 10.
That distinction is one of the most important parts of the inherited IRA rules.
The rules can vary for other types of beneficiaries, so the 10-year rule shouldn’t be viewed as a universal distribution schedule.
Who Is an Eligible Designated Beneficiary?
The SECURE Act created a category known as an eligible designated beneficiary, or EDB. These beneficiaries may qualify for different distribution options than other beneficiaries.
Eligible designated beneficiaries generally include:
- A surviving spouse
- A minor child of the original account owner
- An individual who meets applicable disability requirements
- An individual who meets applicable chronic illness requirements
- An individual who is not more than 10 years younger than the original account owner
Depending on the circumstances, an eligible designated beneficiary may be able to take distributions using life expectancy rather than being immediately subject to the standard 10-year rule.
Special rules apply to minor children. A minor child of the account owner generally qualifies as an eligible designated beneficiary until age 21. The 10-year rule generally begins after the child reaches age 21.
Surviving Spouses Have Additional Options
A surviving spouse generally has more options when inheriting an IRA than a non-spouse beneficiary.
Depending on the circumstances, a surviving spouse may be able to keep the account as an inherited IRA or elect to treat the IRA as their own. The appropriate approach can affect when RMDs begin and how distributions are taxed.
Age can also matter. For example, keeping an IRA as an inherited account rather than immediately treating it as the spouse’s own may have different consequences when the surviving spouse is younger than age 59½.
Because the rules and tax consequences vary, surviving spouses may want to evaluate their options before moving inherited assets.
What About Estates, Charities, and Trusts?
The rules become more complicated when the beneficiary isn’t an individual.
An estate or charity, for example, isn’t considered a designated beneficiary. Distribution requirements generally depend on whether the original owner died before or after their required beginning date.
If the owner died before the required beginning date, the five-year rule generally applies. If the owner died on or after the required beginning date, distributions may instead be based on the original owner’s remaining life expectancy.
Trusts require additional consideration. Depending on how a trust is structured and whether it meets specific requirements, its underlying beneficiaries may be considered when determining the applicable distribution rules.
Because beneficiary designations can significantly affect how quickly retirement assets must be distributed, they can be an important part of retirement and estate planning.
Traditional and Roth Inherited IRAs Have Different Tax Considerations
The distribution rules are only part of the picture. Beneficiaries should also consider how withdrawals may affect their taxes.
Traditional IRAs
Distributions from an inherited traditional IRA are generally included in taxable income, except to the extent the account contains after-tax basis.
For beneficiaries subject to the 10-year rule, the timing of distributions can affect taxable income from year to year. Waiting until the final year to take a large distribution, for example, could result in substantially more taxable income during that year.
However, spreading distributions evenly isn’t necessarily the best approach for everyone. Income, tax rates, other financial resources, and future circumstances can all affect the decision.
Roth IRAs
Inherited Roth IRAs are also generally subject to beneficiary distribution rules, including the 10-year rule for many beneficiaries.
Because Roth IRA owners aren’t subject to lifetime RMDs, a designated beneficiary subject to the 10-year rule generally doesn’t have to take annual distributions during years one through nine. However, the inherited account generally must be fully distributed by the end of year 10.
Qualified Roth IRA distributions are generally tax-free. However, special rules can apply if the Roth IRA hasn’t satisfied the applicable five-year requirement.
This can make the timing of inherited Roth IRA distributions an important planning consideration, but there isn’t one distribution strategy that is appropriate for every beneficiary.
What Happens If You Miss an RMD?
Failing to take a required distribution can result in an excise tax.
Current law generally imposes a 25% excise tax on the amount that wasn’t distributed as required. The tax may be reduced to 10% if the shortfall is corrected and other requirements are satisfied within the applicable correction period.
The IRS may also waive the tax when a shortfall was due to reasonable error and reasonable steps are being taken to correct it. Form 5329 is generally used to report an RMD shortfall and request a waiver when applicable.
Because the rules depend heavily on individual circumstances, beneficiaries shouldn’t assume that simply emptying an account within 10 years satisfies every RMD requirement.
What Should You Do After Inheriting an IRA?
Before deciding when to take distributions, start by understanding which rules apply to the account.
Consider:
- Confirming the type of account. Traditional and Roth IRAs can have different tax consequences.
- Determining your beneficiary classification. Spouses, eligible designated beneficiaries, other designated beneficiaries, and non-designated beneficiaries may follow different rules.
- Finding out whether the original owner had reached their required beginning date. This can determine whether annual RMDs are required during the 10-year period.
- Checking for a year-of-death RMD. If the original owner was required to take an RMD for the year they died and hadn’t taken the full amount, the remaining distribution generally still must be taken.
- Reviewing the tax impact before taking large distributions. Withdrawals from a traditional inherited IRA can affect taxable income.
- Reviewing beneficiary designations on your own accounts. An inheritance can also be a useful reminder to make sure your retirement and estate planning documents reflect your current wishes.
Inherited IRA rules can be complex, and seemingly small differences in beneficiary status or timing can lead to different distribution requirements. Consider coordinating with your financial and tax professionals before making significant distribution decisions.
The Bottom Line
The 10-year rule is often the first thing people hear about inherited IRAs, but “empty the account within 10 years” doesn’t tell the whole story.
Some beneficiaries must take annual RMDs during the 10-year period, while others may have more flexibility. Surviving spouses and other eligible designated beneficiaries may have additional options, and estates, trusts, and other non-individual beneficiaries can face different requirements altogether.
Understanding who inherited the account, what type of account it is, and whether the original owner had reached their required beginning date can help determine which rules apply.
At Navalign Wealth Partners, we help clients consider inherited assets within the context of their broader financial plan. If you’ve inherited an IRA or are reviewing how your own retirement accounts fit into your estate plan, contact our team to discuss your financial planning needs.