An individual retirement account (IRA) is a tax-advantaged retirement account managed by an individual. It can be inherited like other assets, but the rules surrounding transferring IRAs to beneficiaries are more complicated than those for other forms of investments.
The funds in an inherited IRA can be transferred into a single jointly owned IRA or split into separate inherited IRAs for each sibling. The IRA assets must be transferred to an inherited IRA by December 31st of the year following the original owner’s death.
Contact Us to Speak with a
CERTIFIED FINANCIAL PLANNER™ professional.
What is an IRA?
Unlike 401(k) accounts, which an employer manages, an IRA is a tax-advantaged savings plan that each individual manages for themselves. Money is transferred to a traditional IRA pre-tax. This means that you must pay taxes on the account and its growth when you make withdrawals.
Because the money is sitting in your IRA tax-free for decades, the Internal Revenue Service requires you to take Required Minimum Distributions (RMDs) from your account, starting at age 72 or 73. If you inherit an IRA, you will also be required to take distributions from the account. The exact RMD depends on your age and the amount of money in your IRA. The schedule for RMDs travels with the account, with a few exceptions.
If RMDs were not required, money could sit in your account for decades and pass from generation to generation without the IRS collecting any taxes on the funds.
What are eligible designated beneficiaries?
A beneficiary is the person designated to receive the funds upon the account holder’s death. The beneficiaries directly inherit the account. Some categories of individuals, known as eligible designated beneficiaries, receive special privileges regarding RMDs when they inherit an IRA.
The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 listed the following categories of people as eligible designated beneficiaries:
- Spouses
- Minor children
- Disabled or chronically ill individuals
- Anyone not more than 10 years younger than the account holder
If you fall into one of these categories, you will have more flexibility when withdrawing funds from an inherited IRA. You may be able to use your own predicted lifespan to determine when you must take RMDs. Stretching the RMD payments allows the IRA assets to keep growing without paying taxes for a longer period.
Spouses who inherit an IRA can simply assume ownership of it or roll the inherited account into their own IRA.
Eligible designated beneficiaries, other than spouses, will need to transfer the IRA assets into an inherited IRA. In most cases, eligible designated beneficiaries will begin taking RMDs the year after the original account owner’s death, but they can stretch the RMDs over their predicted lifespan. Rules vary for different groups. If you inherit an IRA, talk with your Frame Wealth Management financial advisor to discuss all your options.
What if you are not an eligible designated beneficiary?
If you inherit an IRA and are more than 10 years younger than the account holder and not a minor child, you are a non-eligible designated beneficiary.
If the original account holder had reached the age at which they are required to take RMDs, non-eligible designated beneficiaries will also need to take RMDs. If you fall into this category, you will be required to withdraw the entire balance of your inherited IRA by the 10th year following the death of the original account holder.
How do adult siblings inherit an IRA?
Adult siblings will probably fall into the category of non-eligible designated beneficiaries. If one of the siblings is disabled or chronically ill and, therefore, is an eligible designated beneficiary, talk with your financial advisor to learn how to maximize your tax savings in this situation.
Adult siblings who inherit an IRA must transfer the IRA assets into an inherited IRA by December 31st of the year following the original account owner’s death. You and your sibling must decide how you want to divide the account or manage it as a single account. The account must remain in the name of the deceased owner. You and your siblings can’t make additional contributions to the account.
Once you and your siblings have rolled the IRA assets into an inherited account, you have 10 years to withdraw and pay taxes on the money in the account. The SECURE ACT 10-year rule only applies to inherited IRAs from original account owners who died after 2019.
If you inherit an IRA from an original account owner who died before 2020, you may be able to stretch your IRA’s required minimum distributions over your expected lifespan instead of following the 10-year rule.
What is the 10-year rule?
As a result of the SECURE Act, people who do not qualify as eligible designated beneficiaries are required to empty an inherited IRA and pay taxes on the distributions within 10 years. There was some ambiguity about whether the funds could be withdrawn in a lump sum closer to the 10-year mark or whether yearly distributions were required.
An updated regulation in February 2022 stated that yearly distributions are required. The penalty for not taking RMDs from an inherited IRA is steep. Your fine is 50% of the required amount to be distributed.
The rules governing RMDs are complex, and distributions from an inherited traditional IRA are taxed as ordinary income. Inheriting an IRA can push you into a higher tax bracket. Consult with your Frame Wealth Management financial advisor to learn strategies to minimize your taxes by taking RMDs.
Give us a call today at 866-395-1786 or contact us online to schedule a meeting and discuss your unique financial needs. Let us be your trusted partner on the path to financial success.
