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Inheriting IRAs from someone other than your spouse

Understand the new distribution rules for inherited IRAs.

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Key takeaways

  • The SECURE Act changed the rules for distributing assets from an inherited IRA upon the death of an IRA owner*.
  • The "stretch IRA" provision has generally been eliminated for non-spousal IRAs. For IRAs inherited from original owners who have passed away on or after January 1, 2020, the new law requires many beneficiaries to withdraw all assets from an inherited IRA or 401(k) plan within 10 years following the death of the account holder.
  • In some cases, it may make sense to disclaim inherited IRA assets because they could increase the total amount of your estate and exceed estate tax exemption limits.

If you are the son, daughter, brother, sister, or even a close friend of an IRA owner who has named you as their beneficiary, it's critical that you—and the owner of the IRA—understand the rules that govern IRA inheritances.

"Some of the rules for inheriting and distributing assets upon the death of an IRA owner changed with the passage of the SECURE Act in December 2019," says Ken Hevert, senior vice president of retirement products at Fidelity. "If IRA owners and their beneficiaries are not careful, they could end up paying higher taxes or penalties and forfeiting the opportunity for future tax-advantaged growth."

Here is what you need to know about inheriting IRA assets as a nonspouse beneficiary. The rules for inheriting IRA assets depend on your relationship to the original IRA owner and the type of IRA inherited. Whatever your situation, a discussion in advance with your attorney or tax advisor may help you avoid any unintended consequences.

The IRS generally requires nonspouse inherited IRA owners to start taking required minimum distributions (RMDs) no later than December 31 in the year following the death of the original account owner. Distributions taken from inherited IRAs are not subject to a 10% early withdrawal penalty in most cases.

With the passage of the SECURE Act, IRA distributions to a nonspouse must be completed within 10 years following the death of the account owner. Previously, if you inherited an IRA or 401(k), you could potentially "stretch" your distributions and tax payments out over your single life expectancy. The SECURE Act has eliminated this so-called "stretch" provision for certain beneficiaries.

As a nonspouse beneficiary, you do not have the option of rolling the assets into your own IRA. If you inherit IRA assets from someone other than your spouse, you have several options:

1. Transfer the assets to an inherited IRA and take RMDs

When a traditional IRA is transferred into an inherited IRA, sometimes also referred to as a beneficiary distribution account, there are RMD rules to follow, set by the IRS. Your options for taking distributions from the IRA are based on when the original IRA owner died.

If the original IRA owner died before December 31, 2019, and

  • Died before reaching age 70½, you can start taking RMDs no later than December 31 of the year following death. You also have the option of distributing your inherited IRA under the 5-year rule. This allows you to take distributions however you like without penalty, so long as all assets are completely distributed from your inherited IRA by December 31 of the 5th year following the IRA owner’s death. Discuss with your tax advisor the potential tax implications of this accelerated withdrawal schedule.
  • Died after reaching age 70½, you may elect to calculate those RMDs by using your own age or by using the original IRA owner's age in their year of death, whichever was longer. This option may be advantageous if the original IRA owner was younger than you. In the case of a nonspouse inheritor, RMDs are generally required to begin in the year after the year of death.

If the original IRA owner died on or after January 1, 2020

  • The SECURE Act requires beneficiaries to withdraw all assets from an inherited IRA or 401(k) plan by December 31 of the 10th year following the IRA owner's death. Exceptions to the 10-year rule include payments made to an eligible designated beneficiary (a surviving spouse, a minor child of the account owner, a disabled or chronically ill beneficiary, and a beneficiary who is not more than 10 years younger than the original IRA owner or 401(k) participant). These beneficiaries can "stretch" payments over their life expectancy. Discuss the potential tax implications and distribution options of this accelerated withdrawal schedule with your tax advisor.

If you are listed as a nonspouse beneficiary along with one or more other beneficiaries, it's important to separate your portion of the decedent's IRA in your name and then complete your first RMD by December 31 of the year following the original IRA owner's death. If you don't meet this deadline, your RMD calculation will be based on the oldest beneficiary's life expectancy. If that person is older than you are, you will need to take a larger distribution.

If you inherit a Roth IRA that was funded for 5 years or more prior to the death of the original owner, distributions can be taken tax-free. Consult a tax advisor if you've inherited a Roth IRA that wasn't funded for 5 years before the original owner passed away.

What to do with the money? If you don’t have an immediate need for the money, leaving the assets in the inherited IRA may be the wisest move over the long term (again, subject to the RMD rules and other considerations, including changes to your tax bracket). This is because the longer you keep the money there, the longer you will enjoy potential tax-deferred growth, or, in the case of an inherited Roth IRA, potential tax-free growth. On the other hand, when you take money out of an inherited IRA, it will generally be taxed as ordinary income. The more you withdraw from an inherited IRA now, the less you will have to build on for the future.

2. Disclaim (decline to inherit) all or part of the assets

If you decline to accept all or part of the IRA assets you are entitled to, they will pass to the other eligible beneficiaries. If no other beneficiaries exist, the assets will pass in accordance with the IRA provider's custodial agreement. For example, with a Fidelity IRA, the assets will pass to the original IRA owner's surviving spouse and, if none, to the owner's estate. A decision to disclaim IRA assets must be made within 9 months of the original IRA owner's death and before you take possession of the assets. This is an irrevocable decision. Therefore, as with any tax-related or estate planning matter, it's critical that you consult a tax advisor or attorney before disclaiming IRA assets.

Other key points to remember

Determine whether you are listed as someone's beneficiary. While it may be a sensitive topic to broach with loved ones, knowing in advance that you are listed as a beneficiary can be helpful. As life events such as marriage, divorce, and death occur, it's in your best interest (and the IRA owner's) to confirm that beneficiary designations are up to date. Remember that IRA beneficiary designations supersede a will.

Request a trustee-to-trustee transfer. Make sure that any assets transfer directly from one account to another or from one IRA custodian to another. There is no option for a 60-day rollover when a nonspouse beneficiary is inheriting IRA assets. If you receive a check, the money will generally be taxed as ordinary income, and is ineligible to be deposited into an inherited IRA you may own at another firm, or back into the inherited IRA that it was withdrawn from to begin with.

Distributions from an inherited IRA can be invested in other accounts. Consider all your options when taking RMDs and other distributions from an inherited IRA. Generally, your distribution is included in your gross income and will be subject to ordinary state and federal income taxes. Once funds are distributed from an inherited account, the money is your own.

Commingling of inherited IRAs. If you inherit IRAs from different owners, you cannot combine them into a single inherited IRA. As for commingling IRAs of the same account type, the answer differs when they were inherited from the same original owner, which is allowed. Consult a tax advisor regarding your situation. Distribution rules will vary for entities such as trusts, estates, and charities.

Nonspouse beneficiaries do not have bankruptcy protection with inherited IRAs. In 2005, the US Supreme Court ruled that an inherited IRA held by a nonspouse beneficiary is not exempt from attachment by creditors under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. While some states have laws that still may protect inherited IRAs, for a nonspouse beneficiary living in a state without such laws, the inherited IRA is effectively now treated as any other account owned by the beneficiary for bankruptcy purposes, and may not be protected under bankruptcy from claims by creditors. It is not clear whether and how this decision affects an inherited IRA held by a spousal beneficiary. Beneficiaries should be reminded to speak with their attorney or tax advisor before taking any distribution from a retirement account or if they have specific questions regarding protection from creditors.

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