Many readers of my column ask me specific questions regarding beneficiaries of their individual retirement accounts. I do my best to answer the questions. However, it’s important that owners of IRAs themselves take steps to inform and educate their beneficiaries about what their options will be once they inherit the accounts.
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The regulations that apply to individuals who inherit IRAs are complex. The regulations that apply to spouses are very different from other beneficiaries. Owners of IRAs should explain to their beneficiaries the importance of knowing their options about withdrawals, as well as what reliable resources are available to help them invest their inheritance.
First, beneficiaries should understand when they are required to make withdrawals in order to satisfy IRS requirements. Regulations about required distributions were significantly changed by the SECURE Act or 2019 and the SECURE 2.0 Act of 2022.
Surviving spouses retained their option to roll over their inherited IRA to their own IRA, which allows them to make withdrawals based on their life expectancy. However, they have other options, such as keeping the inheritance as an inherited IRA if they are younger than 59 1/2, which would enable them to take money out of the account without incurring an early withdrawal penalty. After reaching 59 1/2, they would still be able to roll over the inherited IRA to their own IRA.
Most non-spouse beneficiaries, however, are now required to withdraw all the assets in the inherited IRA within 10 years, starting from the year after the inheritance. In some cases, they are required to make yearly withdrawals.
For example, if the deceased owner of the IRA had already reached the age at which yearly minimum distributions were required (known as RMDs), then the non-spouse beneficiary would be required to take yearly withdrawals based on their age, and after the 10-year period, all of the remaining assets would have to be withdrawn. If the deceased owner had not reached the age of RMDs, then the beneficiary would not have to make yearly withdrawals, but would still have to withdraw all the assets remaining in the inherited IRA account by the end of the 10-year period.
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If the inherited IRA is sizable, and withdrawal at the end of 10 years would push the beneficiary into a high marginal tax bracket, that individual might be better off making yearly withdrawals at a lower marginal tax rate rather than making a large withdrawal at the end of the 10-year period.
Beneficiaries who inherit Roth accounts and are subject to the 10-year rule would also be required to withdraw all the assets remaining in the IRA account at the end of the 10-year period. However, because there would not be any income tax liability associated with the withdrawal of assets in a Roth account, it would likely be most beneficial to that heir to wait until the end of the 10-year period before making withdrawals from the Roth IRA account. This simply maximizes the tax-free income and appreciation potential during the 10-year period.
Original owners of IRA accounts have the advantage of receiving RMDs (if required) from the account custodians — i.e., the financial institution that maintains the IRA account. Generally, by February each year, custodians notify the owner of each IRA the yearly minimum distribution required by the IRS. By contrast, custodians of inherited IRAs are not required by law to advise beneficiaries regarding RMDs.
Reliable sources: Individuals who inherit IRAs and want advice regarding RMDS and/or investment advice can hire a competent certified financial adviser, on a one-time or recurring basis. You can contact IRA expert Ed Slott’s group at www.irahelp.com if you want a referral in your geographic area. Another source for information regarding inherited IRAs is available at a one-time cost from Bob Carlson’s “Guide to Inherited IRAs” at RetirementWatch.com.
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Elliot Raphaelson welcomes your questions and comments at [email protected].