If you have inherited a loved one’s retirement savings since 2020, you may want to seek professional tax or financial advice regarding when you’re required to take a payment from the IRA, and how long you can let your inheritance grow tax-deferred in the IRA. If you fail to take a payment when required, you may be subject to a 50% tax on the missed payment amount. But the tax laws have recently changed, and as of May 2022, a few details of these changes are still in flux pending IRS final regulations. While you seek professional assistance to ensure you’re in compliance with the most current interpretation of the law, the following overview of IRA beneficiary distribution rules may help you understand some of the requirements. (If you inherited workplace retirement savings, like a 401(k) plan, know that the rules for beneficiary distributions are generally the same as for IRAs but options may be limited by the plan.)
The Biggest Change
The SECURE Act of 2019 was primarily intended to help workers save more for retirement but also reduced options for those who inherit tax-qualified retirement savings. IRA beneficiaries who inherit in 2020 or later will typically be required to distribute and pay tax on their inheritance within 10 years of the IRA owner’s death. Only “Eligible Designated Beneficiaries” are allowed to stretch out payments for longer than 10 years. If the IRS’s proposed guidance is finalized without change, some beneficiaries may also be required to take a minimum withdrawal each year during the 10-year distribution window.
You Can Take It All
You can always withdraw more than the minimum required, but this may leave you with a hefty tax bill. Only a qualified Roth IRA distribution will be tax-free. (To be qualified, the distribution must be taken after a 5-year period beginning with the first year for which the IRA owner made a contribution to a Roth IRA.) If you’ve inherited a Traditional, SEP or SIMPLE IRA, you may be able to reduce the tax impact of your inheritance by spreading distributions over several years.
Know the Age of the IRA Owner and Your Beneficiary Type
The options available to you depend on the IRA owner’s age at death and your beneficiary type. If the IRA owner died before April 1 of the year following the year they turned age 72, they are considered as having died before their required beginning date (RBD) for taking required minimum distributions (RMDs). If they died on or after this April 1 date, they are considered as having died after their RBD and will have already begun taking RMDs.
| If IRA Owner Died BEFORE Their RBD (and for Roth IRAs) |
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ELIGIBLE DESIGNATED BENEFICIARY - A beneficiary who meets one of the following criteria:
- Spouse of the IRA owner
- Minor child of the IRA owner
- Disabled or chronically ill
- Fewer than 10 years younger than the IRA owner or older than the IRA owner (e.g., a sibling)
Distribution Options
- Take a minimum payment each year (based on the beneficiary’s life expectancy using the IRS’s Single Life Table). The first payment must be taken by December 31 of the year following the year of death.
OR
- Deplete the IRA by December 31 of the 10th year following the IRA owner’s death, taking payments at any time.
NOTES
Spouse beneficiaries may wait until the IRA owner would have turned 72 to start taking life expectancy payments. Spouse beneficiaries may also treat the inherited IRA as their own, or transfer or roll over the assets to their own IRA.
Minor children, upon reaching the age of majority, must deplete the IRA within 10 years. According to the IRS proposed regulations, children reach the age of majority at 21.
Disabled or chronically ill beneficiaries must provide written documentation of a disability or illness to the IRA custodian by October 31 following the year of death to qualify as an Eligible Designated Beneficiary according to IRS proposed regulations.
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DESIGNATED BENEFICIARY – A human beneficiary that does not meet any of the requirements of an Eligible Designated Beneficiary (e.g., an adult child of the IRA owner)
Distribution Requirement
- Deplete the IRA by December 31 of the 10th year following the IRA owner’s death, taking payments at any time.
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NON-DESIGNATED BENEFICIARY – A non-human beneficiary such as an estate, charity, or trust
Distribution Requirement
- Deplete the IRA by December 31 of the 5th year following the IRA owner’s death, taking payments at any time.
NOTE
If a trust meets the requirements to be an Applicable Multi-Beneficiary Trust or a qualified “look-through” trust, it may be treated as a Designated Beneficiary or Eligible Designated Beneficiary for determining IRA distribution options. Seek competent tax or legal advice if you are a trust beneficiary.
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| If IRA Owner Died ON or AFTER Their RBD |
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ELIGIBLE DESIGNATED BENEFICIARY - A human beneficiary who meets one of the following criteria:
- Spouse of the IRA owner
- Minor child of the IRA owner
- Disabled or chronically ill
- No more than 10 years younger than the IRA owner or older than the IRA owner (e.g., a sibling)
Distribution Requirement
- Take a minimum payment each year (based on the longer of the beneficiary’s or the IRA owner’s life expectancy using the IRS’s Single Life Table). The first payment must be taken by December 31 of year following the year of death.
NOTES
Spouse beneficiaries may also treat the inherited IRA as their own, or transfer or roll over the assets to their own IRA.
Minor children, upon reaching the age of majority, must deplete the IRA within 10 years. According to IRS proposed regulations, children reach the age of majority at 21.
Disabled or chronically ill beneficiaries must provide written documentation of a disability or illness to the IRA custodian by October 31 following the year of death to qualify as an Eligible Designated Beneficiary according to IRS proposed regulations.
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DESIGNATED BENEFICIARY – A human beneficiary that does not meet any of the requirements of an Eligible Designated Beneficiary (e.g., an adult child of the IRA owner)
Distribution Requirement
- Deplete the IRA by December 31 of the 10th year following the IRA owner’s death. The proposed IRS regulations indicate that minimum annual payments (based on the longer of the beneficiary’s or the IRA owner’s life expectancy using the IRS’s Single Life Table) must also be taken each year assets remain in the IRA.
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NON-DESIGNATED BENEFICIARY – A non-human beneficiary such as an estate, charity, or trust
Distribution Requirement
- Take a minimum payment each year (based on the IRA owner’s life expectancy using the IRS’s Single Life Table). The first payment must be taken by December 31 of year following the year of death.
NOTE
If a trust meets the requirements to be an Applicable Multi-Beneficiary Trust or a qualified “look-through” trust, it may be treated as a Designated Beneficiary or Eligible Designated Beneficiary for determining IRA distribution options. Seek competent tax or legal advice if you are a trust beneficiary.
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The SECURE Act changes, like the new 10-year rule, have been in effect since 2020. Only the interpretations of how to apply some of those changes, as specified in the proposed regulations, could be subject to change. The IRS will review public comments on the proposed regulations before it issues final regulations, possibly by the end of 2022. Watch Mainstar Trust’s blog posts for information on any significant changes or clarifications after the IRS releases final guidance.