Inherited IRAs

by Laura Johnson, EA

So, your favorite Aunt Martha left you her IRA. Now what?

Dealing with an inherited IRA is probably the last thing on your mind as you mourn your loss, but if you can set aside some time and mental energy to deal with it now, you will avoid some potentially costly mistakes.

First off it is important to know which set of rules you are dealing with. The SECURE Act, made some sweeping changes to IRAs, including inherited IRAs. This is a brief discussion of rules in effect for inherited IRAs after the passage of the SECURE Act. That is for those decedents who died after 2019. Beneficiaries who inherited IRAs before 2020 use the “old rules” which we will not discuss here.

RMD in the year of death

Was the account owner required to take minimum distributions (RMD)? If so, did they receive the RMD before they died? If the year of death RMD was NOT taken before the date of death, the beneficiary is required to receive it. It will be taxable to the beneficiary, not to the decedent’s estate.

Then things get different.

General rule

The remaining account balance, generally, must be distributed to designated beneficiaries within ten years after the original owner’s date of death. That includes traditional IRA accounts and Roth IRA accounts. It does not matter if the original account holder died before or after reaching the date for RMDs, (currently 72 years of age).

Distributions are not required to be taken each year by a designated beneficiary, though they can be. Inherited Roth IRAs are not taxable. It is clear that those with inherited Roth IRAs should wait as long as possible before receiving distributions to maximize tax-free growth before having to take out the money.  

The case is not so simple for those who inherited traditional IRAs and who will be taxed on distributions. Taking distributions in a lower tax year could be beneficial as waiting to take all of funds in year 10 may cause a much bigger spike in income that could otherwise be avoided.

Of course, you can always take distributions before the 10-years if you need the money.

But a big exception for eligible designated beneficiaries

If an exception applies, the ten-year rule is out and the account generally may be distributed over the life expectancy of the eligible designated beneficiary. That is generally the way it worked under the old rules.

An eligible designated beneficiary includes:

·         surviving spouse

·         child who has not reached the age of majority

·         disabled individual

·         chronically ill individual

·         any other individual who is not more than ten years younger than the account holder

Special note on child beneficiaries. Once the child reaches the age of majority, the account must be distributed within 10 years after that date.

A final consideration

If you have inherited an IRA, consider changing the allocation of assets inside the account. The decedent may have invested in assets suitable for his or her time of life. But that may not be the best asset allocation for another beneficiary. You should talk to your financial advisor about choosing the appropriate asset allocation for your needs.

At John Schachter + Associates Inc., we help our clients make the most of inherited traditional and Roth IRAs. Let us know if we can help you.