Understanding Distribution Rules for an Inherited IRA

19 October 2024

Inheriting an Individual Retirement Account (IRA) can provide financial benefits, but it also comes with complicated rules regarding distributions that both beneficiaries and estate planners need to understand. The distribution rules governing inherited IRAs changed significantly with the passing of the Setting Every Community Up for Retirement Enhancement (SECURE) Act in December 2019. This article will guide you through the essential distribution rules for inherited IRAs, helping beneficiaries navigate the complexities involved.

Types of Beneficiaries

Before delving into the specifics of distribution rules, it is crucial to differentiate between the types of beneficiaries as tax treatment and distribution requirements varies. 

1. Eligible Designated Beneficiaries (EDB): This special category includes spouses, minor children of the deceased, individuals not more than 10 years younger than the deceased, and disabled individuals. A person is considered disabled if they meets the definition of disabled in Internal Revenue Code (IRC) Section 72(m)(7) which states “...an individual shall be considered to be disabled if he is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration”.

2. Designated Beneficiaries (DB): These typically include non-spouse individuals that does not meet one of the requirements to be an EDB.  Qualified trusts that are named as an IRA beneficiary will also be categorized as a DB. To be qualified, a trust must be valid under state law, have identifiable beneficiaries, and be irrevocable or become irrevocable upon the IRA owner's death.

3. Non-Designated Beneficiaries: An IRA beneficiary that does not have a life expectancy is considered a non-designated beneficiary. These include estates, charitable organizations, and nonqualified trusts.

 

Distribution Rules Post-SECURE Act

The SECURE Act significantly altered the landscape for inherited IRAs, eliminating the “stretch IRA” strategy for many beneficiaries. Here are the primary distribution rules for inherited IRAs under the SECURE Act:

1. 10-Year Rule: Most non-spouse beneficiaries are now required to withdraw the entire balance of the inherited IRA within ten years of the original owner's death. This rule applies to traditional IRAs and Roth IRAs alike. Unlike previous regulations, there are no annual withdrawal requirements—beneficiaries can choose when to take distributions, as long as the account is emptied by the end of the tenth year.

2. Eligible Designated Beneficiaries Exceptions: Eligible designated beneficiaries still enjoy more lenient distribution options. 

  • Spousal beneficiaries may choose to treat the inherited IRA as their own, allowing for continued tax-deferral under their own account. 
  • Minor children have the flexibility of taking distributions over their lifetimes until they reach the age of majority, at which point they must adhere to the 10-year rule. 
  • If you are chronically ill or disabled, you can stretch the IRA distributions out over your lifetime.
  • If you are not more than 10 years younger than the account owner, withdrawals can be stretched over your lifetime.

3. Non-Designated Beneficiaries: If the IRA is left to a non-designated beneficiary, different rules apply. Non-designated beneficiaries are required to withdraw all funds within five years of the original owner's death.

Tax Implications of Distributions

Distributions from inherited traditional IRAs are subject to income tax, while distributions from inherited Roth IRAs are tax-free, provided the account has been open for at least five years. Beneficiaries must be mindful of their tax situation when planning withdrawals, especially under the 10-year rule, which may push them into a higher tax bracket if large distributions are taken in a single year.

 

Inheriting an IRA brings the opportunity for significant financial support, but beneficiaries must navigate a set of regulations designed to govern distributions. Understanding the rules surrounding inherited IRAs—especially in light of the SECURE Act’s changes—is essential for effectively managing these assets. Beneficiaries are encouraged to educate themselves about their options and consult with professionals to optimize their inherited IRA strategy, ensuring they can benefit fully from their inherited wealth while navigating the complexities of tax implications.

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Manila Central USA is a provider of tax and document preparation services. We are not attorneys. Manila Central USA, Inc. is not a law firm. We can only provide self-help services at your specific direction. We cannot perform the services that an attorney performs and therefore cannot engage in the practice of law, represent you in court, advise you about your legal rights or the law and select forms for you. We cannot charge a fee for referral of the client to another for services that we cannot or will not perform. If you need legal advice and/or representation, you should contact an attorney or the State Bar of California for a referral. All information on this site are for general informational purposes only and does not, and is not intended to, constitute legal advice nor a substitute for legal advice. If you have any legal questions, you should seek the advice of an attorney. We assume no responsibility or liability for any loss, injury, claim, or damage related to your use of any information from this site, whether from errors or omissions in the content.

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