An inherited IRA, also referred to as a beneficiary IRA, is an account opened for someone who inherits an individual retirement account or retirement plan account when the previous owner passes away. Any person, estate or trust can inherit an IRA, however spouses have more flexibility on how they can use the funds in an inherited IRA.
Since the passage of the SECURE Act, the following information only applies to situations where the original account owner passed away before January 1, 2020. The new law requires beneficiaries to withdraw all assets from an inherited IRA within 10 years of the passing of the original account owner.
If the spouse is the sole beneficiary of the deceased’s IRA, then the spouse can assume the account. The IRS will then treat the IRA as if it has been the living spouses all along. To do this the living spouse must assign themselves as the owner of the existing IRA account and roll over the assets from the deceased account into an existing IRA account or open a new account to roll the funds over to. The funds are available at any time but a penalty will apply to any withdrawals made before the new owner is 59 ½.
Non spouse beneficiaries do not have the same options when it comes to inherited IRA’s as spouses.
If the original owner passed away before December 31, 2019 and before reaching the age 70 ½ the beneficiary can begin taking RMDs no later than December 31 of the year following the death. There is also the option to distribute the inherited IRA under the 5-year rule which allows distributions to be taken without any penalties, as along as all the assets are fully distributed from the inherited IRA by December31 of the 5th year following the original owners passing.
If the original owner passed away before December 31, 2019 and after reaching the age 70 ½ the beneficiary can chose to calculate the RMDs by using their age or using the original owners age during the year of their passing, whichever was longer. This option could be beneficial if the original owner was younger than the beneficiary. In this scenario RMDs are generally required to begin the year following the year of death.
Because of the SECURE Act most IRA beneficiaries must transfer the assets in an inherited IRA within 10 years of the account owners passing if the owner died after December 31, 2019. The is referred to as the 10-year rule. There is no limit on when the money needs to be withdrawn or how often withdrawals need to occur.
The 5-year rule applies to Roth IRA accounts that have been open for at least 5 years at the time the original owner passed. This allows Roth IRA beneficiaries to withdraw contributions tax-free at any time. On the other hand, if the Roth IRA account was less than 5 years old at the time of the original owners passing then taxes on the earning withdrawn will be owed.
For both spouse and non spouse inherited IRA’s the spouse is taxed on each distribution. However, the spouse will not incur the 10% early withdrawal penalty. Any undistributed assets can continue growing tax-deferred for up to 5 years. Withdrawals are taxable as income, at the beneficiaries income tax rate.
Make sure to reach out to a tax advisor to review any potential tax implications with inherited IRA’s. We at Insight are always here to help guide our clients on the best approach during these life changing events. Feel free to give us a call at (925) 659-8020 to speak to one of our Financial Planners.
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