Inherited IRAs and Their Significances for Beneficiaries

Published on May 19, 2022

Part 1: How the New 10-Year Rule Affects Beneficiaries of Inherited IRAs

Have you inherited an IRA from a loved one? Or do you, as an IRA account owner, have a beneficiary noted on your paperwork, who you intend to inherit your IRA?

When someone inherits an IRA, there are tax and financial implications on the inherited assets. Age, financial need, account type, and whether the deceased had already begun taking required minimum distributions are common factors to be aware of.

In these situations, the beneficiary transfers the inherited IRA funds/assets into their own newly created inherited IRA. However, because the rules can be quite complex, the beneficiary would be wise to work with a trusted advisor (a tax attorney, financial planner, or accountant) to minimize tax liability. You can read more about what to do with an inherited IRA in Part 2 below.

Enter the 10-year rule for IRA beneficiaries

A critical matter all IRA owners and beneficiaries should be aware of is the “10-year rule,” which was enacted as part of the SECURE Act. Enacted in 2020, this provision eliminated what had been referred to as the “stretch IRA,” in which all beneficiaries (spouses, children and others) could stretch the payout period over their own lifetime (life expectancy payouts).

The new 10-year rule mandates that most non-spouse beneficiaries now must now distribute the entire IRA account balance within 10 years—technically, by December 31st of the year in which the 10th anniversary of the account owner’s death takes place. Certain “eligible designated beneficiaries” are still permitted to take life expectancy payouts if they wish.

SECURE Act 2.0 proposes raising the age at which an IRA owner must start taking required minimum distributions (RMDs) again—this age was raised from 70½ to 72 in 2020 and the new provision is age 75.  The 10-year rule affects account owners and beneficiaries regarding the required beginning date (RBD) for those distributions.

Because this matter can become complicated and has tax implications based on the distributions, account owners and beneficiaries are wise to seek counsel from a trusted tax or financial advisor.

Inherited IRAs and spouse beneficiaries

The rules are different for spouses who choose to transfer the remaining inherited assets into their own IRA – one that would not need to be labeled as “inherited.” It is best to consult a tax advisor to calculate any distribution amounts that may or may not have to be taken before the survivor reaches his or her RBD for required distributions. The beneficiary may have to take a hypothetical distribution before transferring the remaining balance into their own IRA.

What’s next?

The new RMD starting age of 75 is not yet legislation (it was supposed to become effective on January 1, 2022). The IRS is taking public comments through May 25 on the proposed regulations and there will be a public hearing on June 15. That said, it could take months more before the IRS releases its final regulations. Therefore, now is a good time to review your current RMD status and how the 10-year rule may affect you, if you inherit an IRA.

Part 2: What to do with an Inherited IRA

Spouses and Traditional IRAs: Surviving spouses who inherit a Traditional IRA may transfer the assets over into their own newly created or existing IRA, or open an inherited IRA, which keeps those funds separate from other IRA assets. A surviving spouse under the RMD age must retitle the deceased spouse’s retirement plan to an inherited IRA to avoid the 10% penalty for early withdrawals. The 10-year rule does not apply to spouses.

If there is an immediate need for funds, the surviving spouse can take a lump sum distribution as well, but bear in mind this carries significant tax implications for the beneficiary.

Spouses and Roth IRAs: If the retirement plan is a Roth IRA and the survivor takes a lump sum distribution, there will not be taxes owed if the assets have been in the account for five years following the contribution. The survivor is not required to retitle the Roth IRA.

Children and/or non-spouse beneficiaries: These beneficiaries may not retitle the IRA in their own names but can transfer the funds into a new “inherited IRA.” They may cash out the IRA with a lump sum distribution (and pay taxes on the withdrawals from the Traditional IRA) if they need the money. They must adhere to the 10-year rule regardless of age, so adult children who inherit an IRA, and whose life expectancy far exceeds 10 years, will have to do some financial planning around the distributions from their inherited IRA. Whether the deceased had died before his/her RBD or had already begun taking required minimum distributions are other factors to consider.

NOTE: Previous employer 401(k) plans are subject to the same rules as IRAs when it comes to retitling. Although most individuals roll over funds from their 401(k) to an IRA upon retirement, it is important to know what types of retirement plans the deceased held.

Part 3: What to do When an IRA Beneficiary Rejects the Inherited Assets

If the IRA beneficiary does not want the assets, he or she can disclaim their entire or partial interest in the IRA. There is a limited amount of time in which to do this. Internal Revenue Code Section (IRC Sec.) 2518 allows for this disclaimer, which relieves the beneficiary of any financial benefits (and associated tax benefits) of receiving the assets.

This beneficiary disclaimer is done in writing and it is permanent, so beneficiaries must be certain of their decision. The written disclaimer must be presented to the financial institution holding the assets within nine months of the date of death, or in the case of a minor, within nine months of the date on which the beneficiary attains age 21. The beneficiary is not permitted to direct how the disclaimed assets are transferred or to whom. If these conditions are not met, the inherited IRA goes to the beneficiary (whether they want it or not).

What if There’s More Than One Beneficiary?

When a sole primary beneficiary rejects the inherited IRA, the assets are distributed to contingent beneficiaries. In the case of two primary beneficiaries, all IRA assets would then go to the other who did not disclaim. If no beneficiaries are named, the late IRA owner’s estate becomes the beneficiary unless there is a default provision in the IRA plan agreement. The issues of RMDs, regardless of the beneficiary, still stand.

NOTE: At Next Generation, we strongly recommend that all self-directed IRA owners designate at least one beneficiary to their retirement plan(s), just as they do on life insurance policies or other financial assets. If no beneficiary is designated, the account will be left to the estate.

If you have any questions regarding the above information, please contact our office. You can reach us directly via phone at (888) 857-8058 or via email at Alternatively, you can sign up for a complimentary educational session to speak with a representative 1-on-1, or chat with them via text at (848) 233-4076.