The muddy waters of inheriting an IRA

Pamela Rivers |

In general, so many aspects of inheritance are misunderstood. Pair that misunderstanding with IRS policy changes over the past few years and you have a fairly confusing landscape to navigate when planning to pass on or inherit a retirement account. In hopes of clarifying some of this, we offer you some basics when a death occurred on or after January 1, 2020.

The IRS has created three classes of beneficiaries and each class is instructed to follow different distribution methods:

  1. Eligible Designated Beneficiaries. This includes the spouse, disabled beneficiaries, the chronically ill, the minor child of an IRA holder (grandchildren to do not apply) and beneficiaries less than ten years younger than the deceased.
    1. Spousal beneficiaries may inherit an IRA as their own.
    2. Minor children of the deceased may stretch distributions annually until they reach the age of 21 after which time they must distribute the remainder of the IRA within ten years.
    3. Other eligible designated beneficiaries may opt to stretch distributions over their lifetime in the form of annual required minimum distributions.
  2. Non-Eligible Designated Beneficiaries. This will include most of the beneficiaries that do not fall in the first category and typically will include most adult children of IRA holders.
    1. These beneficiaries may opt to transfer the original IRA to a Beneficiary IRA and then must distribute the IRA funds to themselves over a ten-year period ending on December 31st of the tenth year following the death of the IRA owner. It is imperative that this is done as a trustee-to-trustee transfer and not as an indirect rollover as the IRS 60-day rollover window does not apply in this case.
    2. The IRS has proposed rules to require required minimum distributions (RMDs) annually before the ten year period ends depending on the age of IRA holder on his/her date of death. Various financial custodians are interpreting this proposal differently and we highly recommend having a conversation with your financial professionals if you find yourself in this situation.
  3. Non-Designated Beneficiaries. Charities, estates and non-qualifying trusts fall into this category.
    1. Beneficiaries in this category often will take lump-sum distributions but should they decide to take annual distributions they must use the “ghost” life-expectancy of the deceased IRA holder and refer to tables published by the IRS.

Keep in mind that IRA distributions are taxed as income whether they are distributed by the original owner or the beneficiary. Now that we have made this clear as mud, we invite you to visit with one of our LPL financial advisors for further guidance on this matter. Whether you have inherited an IRA or are planning to pass an IRA along to your loved ones, please consult with a tax advisor or financial advisor first.