When the population of the United States grows older, it is common to inherit an IRA from a mother, father, aunt, uncle, or even a sibling or friend. This often happens when you are nearing retirement age. You have some options regarding how to handle this inherited IRA (unless you inherit an IRA from your spouse, in which case different options apply).
Cash in the IRA Within 10 Years
You always have the option to withdraw money from the inherited IRA. You will pay taxes on the distribution amount, but there is no 10% early withdrawal penalty on the IRA. If you choose this option, you must withdraw the entire inherited IRA by December 31 of the tenth year following the death of the original IRA owner. Although there is no penalty tax, this may not be the best option for you. A large withdrawal from an IRA can mean that up to 37% of it goes directly to federal taxes. State income taxes will also apply.
Exceptions to the 10-Year Rule
Exceptions to the 10-year rule include payments made to a qualified designated beneficiary: the surviving spouse, a minor child of the account owner, disabled or chronically ill beneficiaries, and a beneficiary who is not more than 10 years younger than the original IRA owner or participant in a 401(k) plan. These beneficiaries can “stretch” the payments over their life expectancy.
Stretch IRAs for Deaths Before 2020
As a beneficiary, you must take minimum distribution amounts from the inherited IRA each year based on your life expectancy, using a specific set of rules. These distributions are called Required Minimum Distributions (RMDs). Before the SECURE Act of 2019, you could set up an inherited IRA with you as a beneficiary and take RMDs slowly. This option to take distributions over your life expectancy was often referred to as a “stretch IRA.” The nice thing about this option is that you could always withdraw funds earlier if necessary. The RMD rules simply determine the minimum you must withdraw. Withdrawing more than the minimum has always been allowed.
When Trusts or Other Entities Inherit an IRA
If you represent a trust or another entity rather than an individual person, a different set of rules will apply. You can withdraw money from the IRA, and you will likely have to do so within five years (not 10 years). However, when the beneficiaries of the trust are individuals, those individuals will be treated as designated beneficiaries for determining RMDs.
Designating a Beneficiary for Your IRA
IRAs beneficiaries transcend wills or trusts. Ensure that your beneficiary designations are up to date on your IRAs. If appropriate, ask family members if you are designated as a beneficiary on their accounts. Having this information can be helpful upon their passing.
FAQs
How long do I have to withdraw money from an inherited IRA?
The SECURE Act of 2019 established a 10-year deadline for non-spouse beneficiaries to withdraw all funds from an inherited IRA. The “stretch” IRA that allowed you to extend payments indefinitely (as long as RMDs were taken) has been eliminated. Some beneficiaries, such as spouses and children, can still use the “stretch” method.
Can I withdraw from an inherited IRA without penalty?
You can withdraw funds from an inherited IRA as you wish. You will not face a 10% early withdrawal penalty if you take money from the inherited IRA. However, withdrawals will incur income taxes, and these taxes can be significant if the account is large and you take the money in one lump sum.
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Sources:
– Internal Revenue Service. “Retirement Topics – Beneficiary.”
– House Committee on Ways and Means. “The Setting Every Community Up for Retirement Enhancement Act of 2019 (The SECURE Act), Page 5.”
– Internal Revenue Service. “Relief for Reporting Required Minimum Distributions for IRAs for 2020, Page 3.”
– Internal Revenue Service. “IRS Provides Tax Inflation Adjustments for Tax Year 2022.”
– Internal Revenue Service. “Publication 590-B (2021), Distributions from Individual Retirement Arrangements (IRAs).”
– Internal Revenue Service. “Retirement Plan and IRA Required Minimum Distributions FAQs.”
– Congressional Research Service. “Inherited or ‘Stretch’ Individual Retirement Accounts (IRAs) and the SECURE Act.”
– Vanguard. “Understanding the Basics of Estate Planning, Page 13.”
Source: https://www.thebalancemoney.com/inherited-ira-from-a-non-spouse-2388707
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