In the past, if you were the beneficiary of an Individual Retirement Account (IRA), you could take money out of the account over time based on your life expectancy. These funds were essentially yours. However, there have been new rules for inheriting IRAs that you need to understand now.
The new rules, effective as of December 2022 when President Biden signed the SECURE 2.0 Act, bring significant changes. The biggest change is that IRA beneficiaries must now withdraw all funds within 10 years. It is no longer allowed to take money out based on life expectancy.
These new rules apply to those who inherited IRAs after 2019, primarily non-spouse beneficiaries. Those who inherited IRAs before 2019 can still opt for lifetime withdrawals.
When inheriting an IRA, you need to open a new account in your own name. You cannot deposit the money into an existing IRA account; you must establish a beneficiary IRA account. The funds must be transferred directly into the new account (not as cash withdrawals), or else it will be considered a distribution and subject to taxation.
If the original IRA holder had already started taking Required Minimum Distributions (RMDs) while alive, the inheritor must continue to withdraw money. Barron’s notes that inheritors cannot skip withdrawals and each withdrawal is subject to taxation.
If the IRA account holder had already started taking withdrawals, you need to understand the specifics. You must determine if withdrawals were made in the year the account owner passed away. Failure to withdraw as required by year-end may result in penalties.
If the account owner had not begun taking RMDs, the inheritor can decide when to start withdrawals. They can take out the minimum amount each year, as failing to do so might incur a 25% penalty. As per regulations, all funds from the inherited IRA account must be withdrawn within ten years.
Putnam Wealth Management highlights that due to some confusion surrounding the SECURE 2.0 Act in the 2023 tax year, the IRS will not mandate the required minimum distribution.
Unless you are the deceased account holder’s spouse or under special circumstances, you must empty the inherited IRA account within ten years of the account owner’s death. For instance, if the IRA account holder passed away in 2022, you must deplete the account by 2032.
SmartAsset indicates that your age does not affect this rule. If you are under 59 ½ and not a spouse, you must withdraw funds from the inherited IRA within ten years, without facing penalties.
Rules for inheriting an IRA differ for spouses. Financial and tax services company H&R Block explains that inheriting an IRA as a spouse allows for delayed withdrawals until the age of 72.
When inheriting a deceased spouse’s IRA, you can take withdrawals based on your own life expectancy without the requirement to withdraw all funds within ten years.
The IRS sets a starting date for required minimum distributions. According to Investor.Vanguard, if you turn 72 before December 31, 2023, you must take RMDs that year. Traditional IRA holders must withdraw the minimum amount by April 1 of the following year once they turn 73.
There is a rule to understand when inheriting a Roth IRA. If the funds in the account were not within the original owner’s account for at least five years, you will be taxed upon withdrawal. Before withdrawing, ensure with the account manager that the five-year period has passed.
Some beneficiaries may choose to keep the IRA funds for maximum profit rather than immediate withdrawal. However, minimum withdrawals must be taken annually, or penalties may apply, despite the account amount potentially increasing.
While you can choose how much to withdraw, there is always a minimum withdrawal amount each year. Small withdrawals can help avoid a higher tax bill. Taking out a large sum at once could push you into a higher tax bracket and result in substantial taxes.
If the original account holder wishes to help the beneficiary save on taxes, converting a traditional IRA to a Roth IRA is an option. While taxes are due upon conversion, the beneficiary may save money when inheriting the account.
Taxes differ between the two types of IRAs. Traditional IRAs, being pre-tax, require all withdrawals to be taxed, whereas Roth IRA funds, being post-tax, are not taxed upon withdrawal.
If the original account holder’s assets are below the estate tax threshold, there may be an opportunity to reduce taxes owed. Bankrate reports the estate tax exemption in 2023 is $12.92 million. Any estate taxes paid for the IRA can lower your tax burden, with any excess being subject to taxation.
IRS regulations regarding inherited retirement accounts are subject to change. It is advisable to consult estate planners or financial experts for the latest rules when inheriting an IRA and how to manage taxes.