27 Apr What are the rules when a beneficiary inherits an IRA?

Q. I’m a little confused about what happens when a non-spouse beneficiary inherits an IRA. I understand that you have 10 years to take out all the money. Is it true that you can wait until year 10 to take out the money?
— Confused

A. It’s a great question.

The SECURE Act, which became law in December 2019, made major changes to the rules governing retirement accounts, and especially for non-spouse beneficiaries who inherit those accounts.

Among those major changes were increasing the age at which Required Minimum Distributions (RMDs) must begin from age 70 ½ to 72, and allowing traditional IRA contributions to be made at any age, said Gene McGovern, a certified financial planner with McGovern Financial Advisors in Westfield.

The biggest change, however, affects people who inherit retirement accounts, such as IRAs and 401(k) accounts, from someone who is not their spouse.

The law eliminated the so-called “stretch” IRA for those beneficiaries and replaced it with a new, 10-year rule, he said.

“Under the old rules, a non-spouse beneficiary who inherited a retirement account could stretch out the RMDs over his or her remaining lifetime,” McGovern said. “This allowed the beneficiary to take advantage of tax-deferred growth in the retirement account over many years, well past the lifetime of the original account owner.”

But under the new rules, most non-spouse beneficiaries, referred to as “Non-Eligible Designated Beneficiaries,” must withdraw all funds in the inherited retirement account by the end of the tenth year after the original account owner’s year of death, he said.

The new rules do not require annual distributions, or any distributions at all, within the 10 year period, McGovern said. Thus, a non-spouse beneficiary can choose to wait until the 10 years have passed, or can take distributions of any amount in any year along the way, whether to meet income needs or to reduce overall taxes.

McGovern offered this example. Assume that Louise inherits a traditional IRA account worth $100,000 from her Uncle Harry, who died on March 1, 2020. The 10-year clock begins on January 1, 2021, which is the year after the year of Uncle Harry’s death. Louise must withdraw the balance of the inherited IRA account no later than December 31, 2030, the end of the tenth year.

Until then, she’s not required to withdraw any of the money, which continues to grow tax-deferred, McGovern said.

On the other hand, Louise could make withdrawals of any amount at any time during those 10 years, he said.

Let’s take it a step further.

Even though she’s not required to take annual distributions, she might want to spread them out to avoid having a large bump in taxable income in 2030 that could push her into a higher tax bracket, McGovern said.

“A significantly higher income in that year could also affect Louise’s eligibility for other tax credits and benefits, or even increase her Medicare premiums or the taxable amount of her Social Security benefits, depending on her age at that point,” he said.

So effectively, the new law eliminates Louise’s ability to stretch out the distributions over her lifetime, he said. At the same time, though, within the 10 year window, it gives her much more flexibility to control the timing of her income than she had under the old rules.

McGovern said it’s important to note that surviving spouses are not affected by this new 10 year rule. They can still stretch out distributions from a retirement account inherited from the decedent spouse over their own lifetimes, or roll over the inherited IRA into their own IRA, he said.

The law also carves out a few exceptions to the rule for certain non-spouse beneficiaries.

These include disabled individuals, chronically ill persons, and individuals who are not more than 10 years younger than the decedent, McGovern said. For those beneficiaries, the old stretch rules continue to apply.

There is also a special rule that applies to minor children of the decedent.

“A minor child who inherits a retirement account from a parent must begin taking the RMDs over the child’s lifetime, but only until the child reaches the age of majority,” McGovern said. “At that point, the 10-year rule applies.”

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This story was originally published on April 27, 2020.

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