The rules for inherited IRAs and other retirement accounts have changed in recent years, and these updates affect many people who receive retirement accounts after the death of a loved one. If you are a beneficiary of an inherited IRA or a qualified retirement plan, it’s important to understand what has changed, who is affected, what actions you need to take, and how these changes might impact your income tax situation. This update provides a clear summary of the new rules, explains who needs to pay attention, outlines what you must do, and discusses what these changes mean for people with pending or future inherited IRA accounts.
Summary of What Changed
The most important changes to inherited IRA rules come from two major laws: the SECURE Act of 2019 and SECURE Act 2.0 of 2022. These laws changed how and when beneficiaries must take money out of inherited retirement accounts. The biggest change is the introduction of the “10-year rule,” which affects most non-spouse beneficiaries. There are also new requirements for annual withdrawals, new penalties for missing withdrawals, and special rules for certain types of beneficiaries.
Who Is Affected by the Changes
These new rules affect anyone who inherits an IRA or a qualified retirement plan after January 1, 2020. The rules are different depending on whether you are a spouse, a non-spouse individual, a minor child, a disabled or chronically ill person, or a beneficiary that is a trust or an estate. Here’s a breakdown:
- Spouses: Surviving spouses have more options and can often treat the inherited IRA as their own.
- Non-Spouse Beneficiaries: Most non-spouse beneficiaries must follow the 10-year rule.
- Eligible Designated Beneficiaries (EDBs): This group includes spouses, minor children of the account owner, disabled or chronically ill individuals, and people not more than 10 years younger than the original account owner. EDBs may be able to take withdrawals over their life expectancy instead of the 10-year rule.
- Trusts and Estates: These may have different rules and often must follow the 10-year rule.
Effective Dates
The new rules apply to accounts inherited after January 1, 2020. Some changes, such as the new penalty rules for missed withdrawals, take effect starting in 2025. The age at which required minimum distributions (RMDs) must begin is also changing, with the RMD age rising to 75 in 2033.
Required Actions for Beneficiaries
If you have inherited an IRA or a qualified retirement plan, here are the steps you need to take:
- Identify Your Beneficiary Status
- Are you a spouse, non-spouse, minor child, disabled or chronically ill, or another type of beneficiary?
- Your status determines which rules apply to you.
- Check When the Original Owner Died
- Did the original account owner die before or after their Required Beginning Date (RBD)? The RBD is usually April 1 of the year after the owner turned 73.
- This affects whether you must take annual RMDs during the 10-year period.
- Understand the 10-Year Rule
- Most non-spouse beneficiaries must withdraw all funds from the inherited IRA within 10 years of the original owner’s death.
- If the owner died before their RBD, you do not need to take annual RMDs, but the account must be empty by the end of year 10.
- If the owner died after their RBD, you must take annual RMDs during the 10-year period.
- Calculate Required Minimum Distributions (RMDs)
- If you are required to take annual RMDs, use the IRS life expectancy tables to figure out the amount.
- Missing an RMD will result in a 25% penalty starting in 2025.
- Plan for Income Tax
- Withdrawals from inherited IRAs are usually taxed as ordinary income. This means you pay income tax on the money you take out, except for Roth IRAs, which may be tax-free if certain rules are met.
- The money you withdraw is called “income in respect of a decedent” (IRD). This is money that was never taxed while the original owner was alive, so you must pay tax on it when you take it out.
- Consider Tax Planning Strategies
- You may want to spread out withdrawals over several years to avoid a large tax bill in one year.
- Even if you are not required to take annual withdrawals, taking some money out each year can help manage your income tax.
- Consult a Financial Advisor
- The rules can be complicated, especially if you are an eligible designated beneficiary or if the account is large.
- A financial advisor can help you make the best choices for your situation and avoid costly mistakes.
Implications for Pending Applications and Existing Inherited IRAs
If you are in the process of inheriting an IRA or have already inherited one after January 1, 2020, you must follow these new rules. If you inherited an account before 2020, the old “stretch IRA” rules may still apply, allowing you to take withdrawals over your lifetime. For everyone else, the 10-year rule is now the standard, unless you qualify as an eligible designated beneficiary.
Key Details and Deadlines
- 10-Year Rule: Applies to most non-spouse beneficiaries for accounts inherited after 2019.
- Annual RMDs: Required if the original owner died after their RBD, starting in 2025.
- Penalty for Missed RMDs: 25% penalty for missing an RMD, starting in 2025.
- RMD Age Increase: The age for required minimum distributions will rise to 75 in 2033.
- Special Rules for EDBs: Eligible designated beneficiaries may use life expectancy for withdrawals.
What Is “Income in Respect of a Decedent” (IRD)?
When you inherit an IRA, some of the money in the account has never been taxed. This is called “income in respect of a decedent” (IRD). When you take money out, you must pay income tax on it, just as the original owner would have if they had withdrawn it. This is true for both traditional IRAs and other tax-deferred retirement accounts. Roth IRAs are different because, if certain conditions are met, withdrawals can be tax-free.
Taxation of Inherited IRAs
- Traditional IRAs: Withdrawals are taxed as ordinary income.
- Roth IRAs: Withdrawals are tax-free if the account has been open for at least five years and the original owner was at least 59½.
- IRD Tax: All inherited IRA withdrawals (except qualified Roth withdrawals) are considered IRD and are subject to income tax.
Practical Examples
Let’s look at some common scenarios:
- Example 1: Non-Spouse Beneficiary
- John inherits his father’s IRA in 2025. His father died after reaching his RBD. John must take annual RMDs each year for 10 years and empty the account by the end of the 10th year. Each withdrawal is taxed as ordinary income.
- Example 2: Spouse Beneficiary
- Mary inherits her husband’s IRA. She can roll the account into her own IRA and follow the normal RMD rules for her age. She can delay withdrawals until she turns 73.
- Example 3: Minor Child
- Sarah, age 12, inherits her mother’s IRA. She can take withdrawals based on her life expectancy until she turns 21. After that, the 10-year rule applies, and she must empty the account by age 31.
- Example 4: Disabled Beneficiary
- Tom, who is disabled, inherits his sister’s IRA. He can take withdrawals over his life expectancy, which can help reduce the yearly tax bill.
Why These Changes Matter
The old rules allowed most beneficiaries to “stretch” withdrawals over their entire lifetime, which meant smaller yearly withdrawals and lower taxes each year. The new rules force most people to take out all the money within 10 years, which can lead to higher income tax bills, especially if the account is large. This makes tax planning more important than ever.
What Should You Do Now?
If you have inherited an IRA or expect to inherit one soon, here are your next steps:
- Review Your Beneficiary Status: Find out if you are an eligible designated beneficiary or a regular beneficiary.
- Check the Date of Death: This determines which rules apply.
- Understand Your Withdrawal Options: Know if you must take annual RMDs or just empty the account within 10 years.
- Plan for Taxes: Consider spreading withdrawals over several years to avoid a big tax bill.
- Watch for Penalties: Starting in 2025, missing a required withdrawal will cost you 25% of the amount you should have taken out.
- Stay Informed: Rules may change again in the future. Check the IRS website for the latest updates and guidance. You can find official information about required minimum distributions on the IRS RMD page.
Special Considerations for Immigrants and Non-U.S. Citizens
If you are not a U.S. citizen but inherit an IRA from someone in the United States 🇺🇸, you must still follow these rules. However, there may be extra tax rules or reporting requirements, especially if you live outside the United States 🇺🇸. It’s important to talk to a tax advisor who understands both U.S. and international tax laws.
What If You Have a Trust or Estate as Beneficiary?
If a trust or estate is named as the beneficiary, the rules can be even more complex. In most cases, the 10-year rule applies, but there are exceptions for certain types of trusts. If you are the trustee or executor, you should work with a financial advisor or tax professional to make sure you follow the correct rules and avoid penalties.
Looking Ahead: Future Changes
The SECURE Act 2.0 has already set the stage for more changes, such as raising the RMD age to 75 in 2033. Lawmakers may make more changes in the future, so it’s important to keep up with the latest news. As reported by VisaVerge.com, staying informed about new laws and IRS guidance is the best way to avoid mistakes and protect your inheritance.
Key Takeaways
- Most non-spouse beneficiaries must empty inherited IRAs within 10 years.
- Annual RMDs are required if the original owner died after their RBD, starting in 2025.
- Missing an RMD will result in a 25% penalty, with no automatic relief.
- Withdrawals are taxed as ordinary income, except for qualified Roth IRAs.
- Eligible designated beneficiaries may have more flexible options.
- Tax planning is more important than ever to avoid large tax bills.
- Always check the latest IRS rules and consult a professional if you are unsure.
Final Steps
If you have inherited an IRA or expect to, take these actions now:
- Determine your beneficiary type and the rules that apply to you.
- Check the date of death and whether the original owner reached their RBD.
- Plan your withdrawals to manage income tax and avoid penalties.
- Consult the IRS official guidance for the most up-to-date information.
- Seek advice from a financial or tax professional, especially if your situation is complex or involves international issues.
By following these steps and staying informed, you can make the most of your inherited IRA, avoid costly mistakes, and protect your financial future.
Learn Today
Inherited IRA → A retirement account passed to a beneficiary upon the original owner’s death.
SECURE Act → Legislation from 2019 and 2022 that changed inherited IRA distribution rules.
Required Minimum Distribution (RMD) → The minimum annual withdrawal required from retirement accounts after a certain age or event.
Eligible Designated Beneficiary → Beneficiaries with special status allowing withdrawals based on life expectancy.
Income in Respect of a Decedent (IRD) → Untaxed income inherited that must be reported as taxable income when withdrawn.
This Article in a Nutshell
Inherited IRA rules updated by SECURE Acts now require most beneficiaries to withdraw all funds within ten years, impacting tax planning and withdrawals. Special exceptions exist for certain beneficiaries. These changes increase importance of understanding RMDs, penalties, and consultation with financial advisors to protect your inheritance and manage income taxes effectively.
— By VisaVerge.com
