When you received an individual retirement account (IRA) as a beneficiary in the past, you could spread out the required minimum distributions (RMDs) for an expected lifespan. It was considered your own. Now, there are new rules for inherited IRAs that you need to know about.
The new rules took effect when the SECURE Act 2.0 was passed under President Joe Biden in December 2022. The biggest change was that the IRA beneficiary rules now require all funds to be withdrawn within 10 years. You are no longer allowed to withdraw the funds over an anticipated lifetime.
The new inherited IRA rules apply to people who inherited an IRA after 2019. It only applies to most non-spouse beneficiaries. Those who inherited it before 2019 still have the option to extend the distributions over their lifetime.
Opening a New IRA
Inheriting an IRA means that you need to open a new one in your name. You cannot put the money into an existing IRA, but you do need to create a beneficiary IRA. The cash must be put into the new account directly (without cashing it out), or it will be considered a withdrawal, and you will owe taxes on the entire amount.When Distributions Have Already Started
If the person who created the IRA started getting RMDs before their death, the beneficiaries would have to keep getting them. Barron’s says they cannot stop them, and you will have to pay taxes on each RMD.If the IRA distributions have already started, you need to know it. You need to find out if a distribution occurred for the year the account owner died. If it has not, there will be a penalty for the amount not withdrawn if the withdrawal is not made before the year’s end.
Distributions That Had Not Started Yet
When the RMDs have not started, it is up to the beneficiary to decide when they want to start receiving them. They could take out the minimum each year. If they did not, there would be a 25 percent penalty on the amount they should have withdrawn. The inherited IRA distribution rules still apply, and you must empty the beneficiary IRA within ten years.For tax year 2023, PutnamWealthManagement says the Internal Revenue Service will not require an RMD. This is because there was some confusion about the previous wording in the SECURE Act 2.0 document.
The 10-Year Deadline
Unless you are the spouse of the deceased or fall under one of the other non-spouse exceptions, you must deplete the account within 10 years of the owner’s death. In other words, if the IRA account owner died in 2022, you must empty it by 2032.SmartAsset reveals that your age does not matter. If you have not yet reached 59½ and are not the spouse, you still must withdraw the money from inherited IRAs within the 10-year limit, and no penalty will be applied.
IRA Rules for Spouses
The rules for when a spouse inherits an IRA differ from those of a non-spouse. HRBlock mentions that a spouse can treat the IRA as their own. You can hold off on withdrawals until you reach 72.
Spouses receiving an IRA from their deceased spouse can stretch out the proceeds over their lifespan. They are not required to withdraw it all within 10 years.
When RMDs Are Required
The IRS has a required beginning date (RBD) when you must take your first RMD. Investor.Vanguard says that if you turn 72 on or before Dec. 31, 2023, you must take an RMD that year. When you turn 73, traditional IRA owners must take an RMD by April 1 of the following year.There is one rule you need to know on an inherited Roth IRA. Unless the funds have been in the account for at least five years, including the time during the original owner’s lifetime, you will pay taxes on that money when you withdraw it. Be sure to talk with the account manager to ensure the five-year mark has passed before withdrawing money.
A Tax Strategy
After receiving a beneficiary IRA, some people plan on keeping as much money in the account for as long as possible. While this will enable it to build a bigger amount than would be otherwise possible, it is still necessary to take annual RMDs, or a penalty will apply.Although you can withdraw how much you want, there is a minimum amount that you must withdraw each year. By making smaller withdrawals, you will not face large tax bills. If you withdraw a large balance at a single time, or a lump sum, it could put you into a new tax category, causing you to get a huge tax bill.
When original owners want to help their beneficiaries lower their taxes, they can convert their traditional IRA to a Roth IRA. Taxes will be owed on the amount converted, but it could help beneficiaries save some money when they inherit the account.
Different Types of IRAs Have Different Tax Consequences
The two types of IRAs have two different tax consequences. If it is a traditional IRA, you must pay taxes on all withdrawals because the contributions are made pretax. Contributions to a Roth IRA are after-tax, and there is no tax on the withdrawals.An option to pay some taxes may be available if the deceased person’s estate paid less than the allowable estate deduction. Bankrate says that the deduction in 2023 is $12.92 million. Any estate taxes paid toward the IRA decrease the amount of taxes you owe. Anything above that amount is taxable—even if you did not pay it.
The IRS frequently changes the rules on retirement accounts. Talk to an estate planner or financial expert to understand the latest inherited IRA rules and how they may affect your taxes.
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