An Inherited IRA is an individual retirement account that is established when someone inherits retirement fund assets after the death of the original owner. Following the death of a loved one is already a difficult period. However, it often comes with an extra burden of settling their estate and transferring assets according to their wishes. This can be complicated by the rules and potential tax consequences that are associated with inheriting a qualified tax deferred retirement account. Today’s article does not constitute legal or tax advice, its purpose is to provide a high-level overview of Inherited IRA beneficiary designations and regulations. We hope to help prepare you to make sound decisions and be knowledgeable of the subject matter when speaking to an investment or tax advisor. Furthermore, all the information below comes from the latest guidelines following the passing of the SECURE Act 2.0 in 2020.
1) First, we will review the three different beneficiary designations:
Eligible Designated Beneficiary
- Classified as a spouse, minor child of the deceased, individual less than 10 years younger than the deceased, or someone who is chronically ill or disabled.
Non-Eligible Designated Beneficiary
- You were listed as a beneficiary, but do not fall under one of the categories above.
Non-Designated Beneficiary
- You were not listed as a beneficiary on the account, but you were listed as the beneficiary in a will or received the assets via an estate or trust. In these circumstances, you will need to collaborate with the executor of the estate or the trustee of the trust to determine how the assets will be managed.
2) Next, we will cover some of the options and guidelines associated with each type of beneficiary designation:
Eligible Designated Beneficiary
Option 1 (Spouses Only)
- Transfer the assets to your own IRA
- While these assets can continue to grow tax deferred, you will not be able to take penalty free withdrawals if you are under the age of 59.5
- If the account holder was already subject to required minimum distributions (RMD), you must remove any undistributed amount at the time of the transfer to your IRA
Option 2
- Open an Inherited IRA and take the distributions overtime, these are included in your gross annual income
- Your life expectancy will be used to calculate RMDs
- You have until Dec 31 of the year following their death to begin taking the RMDs, unless you are the spouse, in which case you have until the year the deceased would have reached RMD age
- If the deceased was already RMD age, then you must take at least that amount as a distribution by the end of the current year
Option 3
- Take a lump-sum distribution
- You will miss the potential for tax-deferred growth, and you will pay income taxes on the entire taxable portion of the distribution
Option 4
- Disclaim the account
Non-Eligible Designated Beneficiary
Option 1
- Open an Inherited IRA and take the distributions within 10 years
- You have access to the funds at anytime and they can continue to grow tax deferred for 10 years
- Taxable distributions will be included in your gross income and any money not withdrawn by the end of the 10-year period may be subject to an excise penalty
Option 2
- Take a lump-sum distribution
- You will miss the potential for tax-deferred growth, and you will pay income taxes on the entire taxable portion of the distribution
- There is no 10% early withdrawal penalty
Option 3
- Disclaim the account
Non-Designated Beneficiary
Option 1
- The executor opens an Inherited IRA and distributes the assets within five years if the deceased was under RMD age
- The funds can continue to grow tax deferred for five years
- The funds distributed to the estate or trust’s beneficiaries may be included in your gross income for tax purposes
- There is no 10% early withdrawal penalty
Option 2
- The executor opens an Inherited IRA and distributes assets based on the deceased’s life expectancy if they were of RMD age (73)
- The assets can potentially continue to grow tax deferred
- The funds distributed to the estate or trust’s beneficiaries may be included in your gross income for tax purposes
- The same RMDs would apply as if the deceased were still alive
- There is no 10% early withdrawal penalty
Option 3
- Take a lump-sum distribution
- Immediately access the entire inheritance minus any taxes
- Miss any potential tax deferred growth, and it may bump you into a higher tax bracket
3) Here are a couple of additional considerations to be aware of regarding Inherited IRAs, they are:
Traditional vs. Roth IRA
- Traditional (Pre-Tax)
- Generally taxable at the beneficiary’s current income tax rate
- A 10% early withdrawal penalty does not apply to Inherited IRAs, even if the beneficiary is under 49.5
- This does not apply if the spouse rolled over the Inherited IRA into their personal IRA and are under 59.5 unless certain pre-conditions are met
- Roth IRA (After-Tax)
- If the Roth IRA has been held for at least five years before the original owner’s death, distributions are generally tax free
- If the account was established less than five years before the owner’s death, then distributions may still be taxable until the five-year threshold is met on the original account
Penalties
- If you do not take the RMDs from your account in time, you will be subject to a penalty equal to 25% of the amount that should have been withdrawn
Disclosures:
1) Securities and Advisory services offered through GWN Securities, Inc., Member FINRA/SIPC, a Registered Investment Advisor. 11440 N. Jog Road, Palm Beach Gardens, FL 33418. (561) 472-2700. Laws Financial, Inc. and GWN Securities, Inc. are separate companies.
2) A distribution from a Roth IRA is tax-free and penalty-free provided that the five-year aging requirement has been satisfied and one of the following conditions is met: age 59 1/2, death, disability
3) Information provided should not be considered as tax advice from GWN Securities, Inc. or it’s representatives. Please consult with your tax professional.
