Inherited IRA Rules: What Beneficiaries Need to Know

When inheriting an IRA, understanding the basics of inherited IRA rules is crucial for managing your tax liabilities and ensuring compliance with IRS regulations. The transfer of assets from the original owner to the beneficiary can be complex. We’ve summarized the considerations, including how and when to take required minimum distributions (RMDs) and the impact of recent changes under the SECURE Act. Knowing these rules can help you navigate the financial and tax implications of your inheritance.

When the owner of an individual retirement account (IRA) passes away, they leave their account’s holdings to their beneficiaries. This is usually an individual but also could be a legal entity, such as a trust. Once this occurs, the transfer has a great deal of tax implications and the basic inherited IRA rules can get very complex very quickly.

Naturally, some individuals will choose to take a large lump-sum distribution of assets, but this is rarely advised by financial experts from a tax burden perspective. The wiser choice is RMDs (or required minimum distributions) taken over a span of several years. Typically, you have 10 years from the original owner’s death to empty the IRA, which can help to pay a smaller dose of income taxes over time. What may complicate this situation is when the prior owner has died, and whether they reached their required beginning date to start taking RMDs, and whether the beneficiary is a spouse.

Simply put, yes, distributions from traditional inherited IRAs are taxable. Typically, inherited Roth IRAs are tax free, but rules may still apply.

The SECURE Act of 2019 initiated new rules governing inheritances, including new changes to RMD regulations that will apply starting in 2025. This affects the required beginning date (RBD) that you’ll need to start taking required minimum distributions (RMDs). These changes depend on who you are as the beneficiary:

• For a spouse who is the sole beneficiary: A spouse may wait until the deceased spouse has turned 73 and then rollover the IRA into their own IRA (baring some restrictions).
• For an eligible designated beneficiary (EDB): For non-spouses who are no more than ten years younger than the original owner, EDBs can, according to the IRS, “take distributions over the longer of their own life expectancy and the employee’s remaining life expectancy, or follow the 10-year rule (if the account owner died before that owner’s required beginning date)” or whichever is longer.
• For an individual who is not an EDB: Designated beneficiaries who are not EDBs follow the 10-year rule. In other words, they are required to liquidate inherited accounts by December 31st on the 10^th anniversary of the original owner’s death.
• For entities, such as trusts or charities: Charities, estates, and other types of entities will need to follow the 5-year rule. In other words, they will need to liquidate the account by December 31st on the 5^th anniversary of the original owner’s death.

The beneficiary may be subject to either a 5-year rule or a 10-year rule, in that the inherited IRA account must be liquidated by a certain date. This is usually within 10 years of the original owner’s death.

Formally, the IRS announced that these rules will apply after January 1, 2025; however, if you need to make changes to your accounts before then, it’s best to connect with a tax professional and financial advisor as soon as possible.

Keep the following tips in mind.

• Remember that there may be year-of-death requirements for many beneficiaries.
• These changes impact trusts in complicated ways; talk to your accountant review your options and obligations.
• Rules have been updated for non-spouses so that the 10-year rule applies and that they will need to start withdrawing within a short period of time after the originator’s death.
• Now, it’s more important than ever that beneficiary forms are accurate.