New Inherited IRA Rules For Non-Spouses

Inherited IRA Basics

It’s important to understand that an inherited IRA is an account specifically set up by a designated beneficiary to receive assets from an original retirement account owner’s IRA after they pass away. Such accounts can be either traditional IRAs or Roth IRAs, corresponding to the type of account from which the assets are inherited. (Good To Know: There can be multiple beneficiaries for each IRA set up by an original depositor.)

If you’re one of the beneficiaries of an original IRA owner’s traditional IRA, then you would establish an inherited traditional IRA to deposit those funds. Inherited IRAs are like non-inherited IRAs in that they allow for tax-free growth of the assets within them, although inheritors cannot make new tax-deferred contributions to them.

However, withdrawal rules for inherited IRAs differ from non-inherited IRAs. In most cases, required minimum distributions (RMDs) happen earlier than age 73, when RMDs for original depositors typically begin. They also differ from non-inherited IRAs because in some cases there’s a 10-year period within which non-spouse beneficiaries must deplete an inherited IRA.

What Is A Non-Spouse Beneficiary Of An Inherited IRA?

If you were any of the following to the original owner of the IRA you inherited, you are a non-spouse beneficiary:

• Child of the original owner
• Grandchild of the original owner
• Sibling or other relative of the original owner
• Friend of the original owner

A non-spouse beneficiary who inherits in 2020 or later may also qualify to be treated as an eligible designated beneficiary, which means you may have some unique withdrawal options. (See explanation below.) That may be the case if you are a minor child of the original owner, someone who is not more than 10 years younger or older than the original owner, or you are chronically ill or disabled, or the spouse.

What Are The Rules For Non-Spouse Beneficiaries Of An Inherited IRA?

It’s critical to understand the withdrawal options available to you as a non-spouse beneficiary. Numerous rules apply to withdrawing from an inherited IRA. In addition to understanding the type of beneficiary you are to the original depositor, you also need to be aware of the original owner’s age when they passed away, because your withdrawal options will differ based on whether they had begun or had yet to begin taking RMDs before their passing.

If The Account Owner Passed Away In 2020 Or Later

Generally speaking, most non-spouse beneficiaries inheriting from an original owner will be required to withdraw the balance of their account over 10 years, unless you qualify to be treated as an eligible designated beneficiary.

10-Year Rule For Inherited IRAs

1. If the original owner of your inherited assets passed away before they began taking required minimum distributions, you can elect to transfer inherited assets to an inherited IRA in your name and fully withdraw the account down to zero by the end of the year including the 10th anniversary of their passing. This option allows you to decide how much and how often you withdraw from the account over the course of the 10-year period. As long as the inherited IRA has been fully depleted by the end of the applicable 10-year period, withdrawals (or lack thereof) during that time are up to you.
2. If the original owner of your inherited assets passed away after they began taking required minimum distributions, you can similarly elect to transfer account assets to an inherited IRA in your name and fully withdraw the account down to zero by the end of the year that includes the 10th anniversary of their passing. A major difference in this scenario is that the owner of the inherited IRA must take a required minimum distribution in years 1 through 9, with a full withdrawal of the remaining assets by the end of the year that concludes the 10-year withdrawal period.

Eligible Designated Beneficiaries

If you qualify to be treated as an eligible designated beneficiary, you may be able to withdraw the balance of your account by taking withdrawals based on your age, which for most beneficiaries is longer than 10 years. If you qualify to be treated as an eligible designated beneficiary, you may also elect to follow the 10-year rule or follow the 10 year-rule with RMD withdrawals if the original owner was already required to take RMDs from their account. Eligible designated beneficiaries must begin taking RMDs the year following the original owner’s death.

If The Account Owner Passed Away In 2019 Or Before

Non-spouse beneficiaries inheriting from an original owner who passed away during or before 2019 have the following withdrawal options:

• If the original owner of your inherited assets passed away before they began taking required minimum distributions, you can elect to move the assets into an inherited IRA in your name and fully withdraw the entire account balance by the end of the year following the 5-year anniversary of the original owner’s passing.
• Alternately, you can elect to move the assets into an inherited IRA in your name and fully withdraw the entire account balance by the end of the year following the 5-year anniversary of the original owner’s passing. If the original owner of your inherited assets passed away before they began taking required minimum distributions, you can also elect to move them into an inherited IRA in your name and take required minimum distributions each year based on your life expectancy as shown on the IRS Single Life Expectancy Tables, reduced by a life expectancy factor of 1 in each successive year, beginning in the year after the original owner passed away. Note: This schedule essentially means the inheritor will empty the account faster than the original owner would have.
• If the original owner of your inherited assets passed away after they began taking required minimum distributions, you can elect to move the assets into an inherited IRA in your name and take required minimum distributions each year based on the longer of the original owner’s life expectancy or your life expectancy.

Additional Considerations For Non-Spouse IRA Beneficiaries

Inheriting an IRA can have tax implications for the beneficiary, and it’s always a good idea to consult with a financial professional who can help you understand your individual tax situation.

Disclaiming Inherited IRA Assets – Another option available is disclaiming (declining to inherit) the assets. If you decline to accept all or part of IRA assets you are entitled to, they will pass to the other eligible beneficiaries named on the original owner’s account. 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 or, if there isn’t one, 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. Note: This is an irrevocable decision. Therefore, as with any tax-related or estate planning matter, it’s critical that you consult a tax professional or attorney before disclaiming IRA assets.

Discuss 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 – If you decide to transfer your inherited IRA/inherited Roth IRA, make sure that the assets transfer directly from one account to another, or from one IRA custodian to another.

Important: There is no option for a 60-day rollover─which generally allows a tax- and penalty-free transfer from one IRA or retirement account to another within that time frame─when a non-spouse beneficiary inherits IRA assets. If you receive a check, the money will generally be taxed as ordinary income and assessed a 10% penalty if you are less than age 59½. It is also ineligible to be deposited into an inherited IRA you may own at another firm (unless the inherited IRA was inherited from the same original account owner), or back into the inherited IRA that it was withdrawn from to begin with.

Generally, Distributions From A Non-Roth Inherited Retirement Account Are Considered Ordinary Income And Subject To Federal And State Tax For The Year They Occur – Once the money is distributed and any applicable taxes are paid, you have options regarding what you can do with them. For example, they can be deposited into a checking or savings account and used at your discretion, or they can go into a brokerage account where you elect to allocate them into investments of your choosing. .

Commingling Of Inherited IRAs –  If you inherit multiple IRAs from the same owner, and they are the same type of IRA (i.e., traditional or Roth), they can be commingled in an inherited IRA. Consult a tax professional regarding your situation. Distribution rules will vary for entities such as trusts, estates, and charities.

An Inherited IRA Held By A Non-Spouse Beneficiary Does Not Provide Bankruptcy Protection – While some states have laws that still may protect inherited IRAs, for a non-spouse beneficiary living in a state without such laws, the inherited IRA is effectively 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.

Note: In contrast to an inherited IRA, assets that may be left behind in a 401(k) may benefit from creditor protection under the Employee Retirement Income Security Act (ERISA).

Remember, beneficiaries should consider speaking with an attorney or tax professional before taking any distribution from a retirement account, or if they have specific questions regarding protection from creditors.

Source: Fidelity