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Taking the Mystery Out of Inherited IRAs




When establishing an IRA (including traditional, Roth, SEP, and SIMPLE) or qualified plan account, it’s important to designate beneficiaries to inherit your assets when you pass away. In addition, when life events such as marriage, divorce, or birth of a child occur, this is typically a good time to review and update your beneficiaries accordingly. Upon your passing, your beneficiaries will be required to take distributions from their inherited IRAs, but the payout period and applicable rules depend on who is designated as beneficiary. While the same rules generally apply for both IRAs and qualified plans, a plan document may dictate or limit payout options.

The recent enactment of the SECURE Act (effective January 1, 2020) brought several changes to inherited IRA rules. The following charts will outline inherited IRA distribution options if the account owner passed away in 2020 or after or prior to 2020:


Inherited IRA Options Based on Beneficiary (for death occurring 2020 or after)

Beneficiary Type Death Before Required Beginning Date1 Death After Required Beginning Date1
Spouse
  • Total distribution
  • Five-year rule2
  • Required minimum distributions (RMDs) based on beneficiary’s life expectancy beginning in the year the IRA owner would have turned age 72
  • Rollover to own IRA
  • Total distribution
  • Distribute RMD for year of IRA owner’s death (if not already taken) and continue RMDs based on the longer of the deceased IRA owner’s life expectancy or own life expectancy
  • Rollover to own IRA (may need to satisfy deceased’s RMD if not taken prior to passing)
Estate, Charity, or Non-Qualified Trust
  • Total distribution
  • Five-year rule2
  • Total distribution
  • Distribute RMD for year of IRA owner’s death (if not already taken) and continue RMDs based on the deceased IRA owner’s life expectancy

In 2020 or after, the required beginning date is April 1 of the year after reaching age 72.
Five-year rule does not require a distribution in any year, but the inherited account must be fully distributed by December 31 of the fifth anniversary of death.

Beneficiary Type Following Death of Account Owner1
Non-Spouse2
  • Total distribution
  • Ten-year rule3
Qualified Trust4
  • Total distribution
  • Ten-year rule3

If the original IRA owner did not fully satisfy his or her current year RMD before passing, the beneficiary must satisfy the remaining RMD for the deceased by December 31 of the year of death.
2 Non-spouse beneficiary exceptions that may still take RMDs over their life expectancy include disabled and chronically ill individuals, minor children of the deceased account owner, and non-spouse beneficiaries who are no more than 10 years younger than the deceased. Please note, once minor children reach the age of majority in their state, the ten-year rule will apply.
3 Ten-year rule does not require a distribution in any year, but the inherited account must be fully distributed by December 31 of the tenth anniversary of death.
4 Certain trusts, including charitable remainder trusts and “see-through” trusts benefiting an eligible beneficiary, may avoid the ten-year rule and allow for longer payout periods. If naming a trust as beneficiary, it is important to consult with a trust attorney.


Inherited IRA Options Based on Beneficiary (for death occurring prior to 2020)

Beneficiary Type Death Before Required Beginning Date1 Death After Required Beginning Date1
Spouse
  • Total distribution
  • Five-year rule2
  • RMDs based on beneficiary’s life expectancy beginning in the year the IRA owner would have turned age 70½
  • Rollover to own IRA
  • Total distribution
  • Distribute RMD for year of IRA owner’s death (if not already taken) and continue RMDs based on the longer of the deceased IRA owner’s life expectancy or own life expectancy
  • Rollover to own IRA (may need to satisfy deceased’s RMD if not taken prior to passing)
Non-Spouse
  • Total distribution
  • Five-year rule2
  • RMDs based on beneficiary’s life expectancy starting in the year after death
  • Total distribution
  • Distribute RMD for year of IRA owner’s death (if not already taken) and continue RMDs based on the beneficiary’s life expectancy starting in the year after death
Qualified Trust
  • Total distribution
  • Five-year rule2
  • RMDs based on the oldest beneficiary of the trust’s life expectancy starting in the year after death
  • Total distribution
  • Distribute RMD for year of IRA owner’s death (if not already taken) and continue RMDs based on the oldest beneficiary of the trust’s life expectancy starting in the year after death
Estate, Charity, or Non-Qualified Trust
  • Total distribution
  • Five-year rule2
  • Total distribution
  • Distribute RMD for year of IRA owner’s death (if not already taken) and continue RMDs based on the deceased IRA owner’s life expectancy

1 Prior to 2020, the required beginning date was April 1 of the year after reaching age 70½.
2 Five-year rule does not require a distribution in any year, but the inherited account must be fully distributed by December 31 of the fifth anniversary of death.

SUCCESSOR BENEFICIARIES

Beneficiaries who inherit IRAs and qualified plans may designate successor beneficiaries to inherit the account when that primary beneficiary passes away. If the original account owner died in 2019 or prior with a non-spouse beneficiary that passes away in the future, the successor beneficiary will be subject to the ten-year rule upon the primary beneficiary’s passing. If the original account owner died in 2020 or after with a non-spouse beneficiary that passes away in the future, the successor beneficiary will continue the original beneficiary’s ten-year rule. (Note: The 10 years does not reset.)

IMPORTANCE OF STRETCHING AN IRA

The stretch strategy is utilized by having the IRA owner and beneficiaries distribute only their RMD each year. This allows the IRA to continue to compound earnings in a tax-deferred manner over the life expectancy of both the IRA owner and primary beneficiary, thus stretching the IRA over a maximum period of time and minimizing taxation each year. Generally, IRA and qualified plan owners that passed away in 2019 or prior may allow their beneficiaries to utilize the stretch strategy. For death occurring in 2020 or after, spouse beneficiaries and certain non-spouse exempt beneficiaries may take advantage of the stretch strategy.

DISTRIBUTION TAXATION AND PENALTIES

Although distributions are taxed as ordinary income at the beneficiary’s rate, the 10% penalty for distributions before age 59½ is waived for inherited IRA distributions. However, failure to take an RMD by the deadline (typically December 31 each year) will result in a 50% penalty on top of ordinary income tax for the undistributed amount. RMDs from inherited IRAs generally begin in the year after death, unless the deceased had not fully satisfied his or her RMD prior to passing. If the deceased had not fully satisfied his or her RMD, the beneficiary(ies) must satisfy it by December 31 of the year the IRA or qualified plan owner passed.

This information is for educational purposes only. Stifel does not provide legal or tax advice. You should consult with your legal and tax advisors regarding your particular situation.

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