Navigating Inherited IRA Rules: Key Changes and Strategies Post-SECURE Act
Recent changes brought about by the SECURE Act and SECURE 2.0 Act have added complexity to inheriting an IRA. The estate planning and tax benefits once provided by the stretch IRA are largely no longer available, necessitating new strategies and tax planning approaches.
Previously, the stretch IRA allowed IRA holders to designate younger relatives, such as great-grandchildren, as beneficiaries. These young beneficiaries’ longer lifespans meant that required minimum distributions (RMDs) were minimal, allowing the bulk of the IRA to grow tax-deferred with low tax impact.
Now, the stretch IRA has been replaced with a rule requiring the IRA to be distributed within 10 years to the beneficiary.
Rules for Spouses
Surviving spouses have some advantages compared to other beneficiaries. They can roll over inherited IRA assets into their own IRA, treating these assets as their own. This allows them to delay RMDs until they turn 73, effectively continuing the stretch IRA strategy. This option is available even if the deceased spouse had already reached 73 and started taking distributions.
However, if the deceased spouse had started RMDs but didn’t complete the necessary withdrawal before passing, the RMD must still be taken.
Regular IRA rules still apply. For instance, if you’re under 59 ½ and take distributions, a 10% early withdrawal penalty will apply.
Surviving spouses can also choose to follow the standard rules for an inherited IRA. This involves transferring the assets to a new IRA in the beneficiary’s name. This option is useful for those under 59 ½ who need to take distributions, as inherited IRAs are exempt from the 10% penalty. If the original owner hadn’t turned 73, RMDs can be postponed until the year the deceased would have turned 73.
Once the surviving spouse reaches 59 ½, the inherited IRA can be rolled into their own IRA, with RMDs starting at age 73.
These options come with different tax implications, and withdrawals are treated as ordinary income. Minimizing annual withdrawals might be beneficial depending on the overall financial situation and other available income sources.
Rules for Non-Spouse Beneficiaries
The SECURE Act provides another “stretch” exception for certain heirs, termed eligible designated beneficiaries. These include minor children, individuals who are chronically ill or disabled, or those not more than 10 years younger than the original owner. This group can transfer assets into an inherited IRA and take RMDs based on their life expectancy.
This can be advantageous for preserving and growing the account, as longer life expectancies lead to smaller annual distributions. However, eligibility for disability and chronic illness is specifically defined, and minor children can only use stretch provisions until they turn 21. After 21, the account must be distributed within 10 years.
For non-eligible designated beneficiaries, the account must be fully distributed within 10 years after the original owner’s death.
Strategies for Non-Spouse Beneficiaries
Non-spouse beneficiaries can adopt strategies to create tax efficiency and preserve capital. Coordinating distributions with periods of lower income can minimize tax impact. Taking distributions during market downturns can enable tax loss harvesting, lowering overall tax liability, and reinvesting at lower asset prices can help the account grow as the market recovers.
For inherited Roth IRAs, withdrawals are tax-free. Allowing the account to grow as long as possible is often the best strategy, though it’s important to meet certain conditions and seek professional advice.
Conclusion
Inheriting an IRA involves navigating complex rules and making strategic decisions that impact your long-term financial and tax situation. From identifying your beneficiary status to managing RMDs and choosing between transfer or rollover options, getting it right is crucial. Consulting with a professional to tailor decisions to your overall financial goals is highly recommended.
Disclaimer:
The information provided in this financial planning post is intended for general informational purposes only and should not be construed as personalized financial, investment, tax, or legal advice.
Financial planning is a complex and highly individualized process that takes into account your unique financial situation, goals, and risk tolerance. While this post aims to provide useful insights and guidance, it is not a substitute for professional advice tailored to your specific circumstances. We strongly recommend that you consult with a qualified financial advisor, tax professional, or legal expert before making any financial decisions or implementing any financial strategies. Any decisions made based on the information in this post are solely at your own risk.