Inherited Retirement Accounts - Non-Spouse Beneficiaries

Note: RMD rules may vary for your own retirement accounts or if you have inherited the retirement account from your spouse. To learn more, review the following content: Inherited IRAs for Surviving Spouses and Frequently Asked Questions About RMDs.

Understanding Inherited Retirement Accounts

Everyone appreciates an inheritance left by a loved one. When you inherit a retirement account, it is important to understand the rules that apply. A required minimum distribution (RMD) is the amount the IRS mandates to be distributed from an individual retirement account (IRA) or other retirement account on an annual basis, and this distribution is typically 100% subject to ordinary income tax rates. The primary factors that determine whether an RMD must be taken from the account, as well as the timing and requirements, are as follows: (1) the date the account holder passed away (2) the beneficiary’s relation to the deceased account owner, and (3) the type of retirement account inherited.

Outlined below are general rules for RMDs when a non-spouse beneficiary inherits a retirement account. In all scenarios below, there are no early withdrawal penalties for distributions made to beneficiaries under age 59½. We recommend working with your CPA to ensure you take the correct RMD, as missed RMDs incur a 50% penalty.

The SECURE Act – Elimination of Stretch IRAs

The rules for RMDs for inherited retirement accounts vary based on the date when the account holder passed away. The SECURE Act, passed in December 2019, provided significant changes to the distribution requirements of retirement plans, but only for retirement account owners who pass away on or after January 1, 2020.[1] As discussed below, accounts inherited from decedents that passed away before 2020 could be “stretched” over the lifetime of the non-spouse beneficiary. In contrast, accounts inherited from decedents that passed away in 2020 or later must be distributed entirely by the end of the tenth year following the account owner’s passing. Certain classifications of beneficiaries, defined below as Eligible Designate Beneficiaries, have more flexible, though possibly complex, rules similar to the “Stretch IRAs” for beneficiaries prior to the SECURE Act.

Pre-SECURE Act & Inherited Traditional IRAs – Death of Account Owner on or before 12/31/19

If you previously inherited an IRA, the new rules do not apply if the owner passed away before 12/31/2019.

Beneficiary Is An Individual. If you are a non-spouse beneficiary, you must roll the account to an inherited IRA (also called a Beneficiary IRA) by 12/31 of the year after the account owner’s death.

Account owner dies on or before the required date to begin RMDs. There is no RMD required for the year-of-death. However, you must take RMDs beginning the year after the year of the account owner’s death. You generally must base the RMD for years after the year of the owner’s death using the Single Life IRS life expectancy table for your own age at the year-end following year of decedent’s death and reducing the beginning life expectancy by one for each subsequent year. An individual designated beneficiary may be required to take the entire account by the end of the fifth year following the year of the owner’s death.

Account owner dies on or after the required date to begin RMDs. The deceased owner’s RMD must be distributed in the year of death. If the decedent had not withdrawn the entire RMD, you must take the remaining RMD before transferring the decedent’s IRA. You may roll the account into an inherited IRA. Distributions must begin no later than 12/31 of the year of the account owner’s death. The annual distributions can be stretched over the longer of your own single life IRS life expectancy table or the deceased owner’s life expectancy.

Beneficiary Is Not An Individual (e.g., estate, charity, or some trusts).

Note on Trusts: Some trusts qualify as “conduit” or “see-through” trusts, as they “see-through” to the underlying beneficiary. Other trusts do not qualify for this exception, and will follow the RMD rules below. The RMD rules will be applied based on the current income beneficiary. If you are the trustee of a trust that is the beneficiary of an inherited IRA, contact your estate attorney to confirm the RMD distribution rules.

Account owner dies on or before the required date to begin RMDs. The entity must take the entire account balance by the end of the fifth year following the year of death. There are no RMDs during the five-year period.

Account owner dies on or after the required date to begin RMDs. The entity generally must base the RMD on the account owner’s death using the Single Life IRS life expectancy table for the decedent’s age as of their birthday in the year of death and reducing the beginning life expectancy by 1 factor for each subsequent year.

Multiple beneficiaries. Separate inherited IRAs must be established for each beneficiary by 12/31 of the year following the year of death. Otherwise, distributions may be based on the least flexible distribution option, such as the age of the oldest beneficiary.

Post-SECURE Act & Inherited Traditional IRAs – Death of Account Owner on or after 01/01/20

If you inherited a retirement account from a loved one that passed away after January 1, 2020, the same options apply.  The account may be rolled into an inherited IRA held for your benefit or may be taken as a lump sum. However, rather than RMDs “stretching” over your life expectancy, most non-spouse beneficiaries must withdraw all assets held in inherited retirement accounts in the year that contains the tenth anniversary of the account owner’s death. While it is believed the accounts must be withdrawn by December 31st of the year containing the 10th anniversary, recent IRS proposed regulations caused confusion as they indicate that minimum distributions are required annually until the term ended on the 10th anniversary of the beneficiary’s death.[2] Given the recently published regulations are still proposed, we do not yet have final guidance as to which of the contradicting regulations to follow. A recent IRS Notice confirms distributions are not required for years 2021 and 2022. However, two things are clear, within the ten years there may or may not be distribution requirements as long as the entire account balance has been distributed by the 10 year deadline, and guidance from a CPA is required.

As a general example, suppose Charlie Jones passed away on January 18, 2021, and had not taken his 2021 RMD as of the date of his death. Charlie named his niece, Jane, age 30, as his primary beneficiary. In 2021, the year of death, Jane must take Charlie’s remaining RMD before transferring the assets to an inherited account, and Jane will be liable for the tax on any year-of-death RMD received. Jane then transfers the remaining funds to an inherited IRA. Although Jane may or may not be required to take annual RMDs over the ten-year term, she must withdraw all inherited retirement assets no later than 2031 (either January 18, 2031, or December 31, 2031, pending further guidance).

Eligible Designated Beneficiaries – Exceptions to the New Rules

Even if the original account owner passed away on or after January 1, 2020, certain beneficiaries may qualify as “Eligible Designated Beneficiaries” and are not subject to the 10-year rule. Eligible Designated Beneficiaries include the five following categories and are generally subject to different distribution rules similar to the life-expectancy payouts above.

Status as an Eligible Designated Beneficiary is determined at the date of the owner’s death and cannot be changed. The IRS has not yet released the Treasury Regulations related to the SECURE Act; information below may be subject to change.

The Surviving Spouse – The rules remain unchanged before and after the enactment of the SECURE Act. As the surviving spouse, you may treat the inherited account as your own by rolling it over to your own IRA, or you may roll the account into an inherited IRA (also called a Beneficiary IRA). Click here for more detail on inherited retirement accounts for surviving spouses.

Other beneficiaries that are not more than 10 years younger than the (deceased) retirement account owner, certain disabled, and/or chronically ill individuals – If you qualify under these three exceptions, you may distribute your inherited IRA over your life expectancy. You must take RMDs beginning the year after the year of the account owner’s death.

Minor Children – If the beneficiary is a minor child of the deceased account owner, the distribution rules for inherited accounts are a hybrid of the new and old rules. The same rules do not apply to other beneficiaries that may be minors such as grandchildren, nieces, nephews, etc.

If the account owner’s child-beneficiary is a minor at the time of the owner’s death, the child must take annual RMDs under the “life expectancy payout” until reaching the age of majority. Then, the ten-year period begins.

What is the age of majority? Although the IRS has not released guidance, the age is expected to be between 18 and 26 years old, depending on state law and potentially until the minor completes certain education levels.

From our last example, assume Charlie named his minor daughter, Penelope, age 10. If his niece, Jane, had been the beneficiary (regardless of Jane’s age), Jane was required to withdraw all inherited retirement assets no later than 2031. The same rules apply if the account owner’s child has reached the age of majority.

However, because Penelope was a minor at the time of her father’s death, the year following her father’s death and all years until Penelope attains the age of majority, the annual RMDs will be based on Penelope’s life expectancy. Assuming Penelope attains the age of majority at age 26, the ten-year term will begin in 2037. All assets must be distributed no later than 2046 (pending IRS guidance, either on December 31st or on Penelope’s 36th birthday, which is the 10th anniversary of Penelope attaining the age of majority). Because Penelope was the minor child of the decedent, Penelope benefits from 26 years of tax-deferred growth of the assets.

Legacy Planning Tips

Owners of large retirement accounts who were previously planning on leaving these assets to beneficiaries in high tax brackets may consider Roth conversions more attractive now, knowing distributions to beneficiaries are tax-free. If beneficiaries are expected to be in lower tax brackets, although the new 10-year rule does limit the “stretch” IRA, it may make sense to let them take distributions over ten years rather than converting to a Roth IRA, which would require the IRA owner to pay related income taxes upfront. Meet with your estate attorney to determine whether any changes need to be made to your beneficiaries, especially if you have a trust-named beneficiary, as the SECURE Act changes could impact it.

Inherited Roth IRAs

Regardless of the account owner’s age at death, inherited Roth IRAs must be distributed either over ten years, over the beneficiary’s life expectancy, over five years, or in a lump sum. In addition, most non-spouse beneficiaries must withdraw all assets held in inherited retirement accounts by the tenth year following the account owner’s passing. Within the ten years, however, there are no distribution requirements, which does provide flexibility as to when the distributions are made so long as the entire account balance has been distributed by the end of the tenth year.

Inherited Employer-Sponsored Retirement Plans (e.g., 401(k)s)

The terms vary by company and by the plan. Generally, employer-provided retirement plans require that the funds left in an account be withdrawn within five years of the employee’s death.  However, for simplicity and ease of investing purposes, many people choose to roll all inherited retirement plans into an inherited IRA.

Beneficiary Is Not An Individual (e.g., estate, charity, or some trusts)

The same rules apply as pre-SECURE Act.

For more information on RMDs, click here for our Frequently Asked Questions for Account Owners. Additional information may be found on:

  • How Should You Withdraw RMDs
  • Should You Consider Directly Transferring Some or All of Your RMD to Charity?
  • RMDs and Taxes

[1] The effective date is extended for two years for certain governmental plans, and will apply to account owners of such plans that pass away before 12/31/2023.

[2] We are pending guidance on this topic from the Treasury Department. Although it is believed the 10-year period would end on December 31st of the year of the 10th anniversary, a recent IRA Publication stated it may be on the 10th anniversary of death or child’s age of attainment. Click here for more information.

 

Important Disclosure: This report is for informational purposes only. Opinions expressed herein are subject to change without notice. Beacon Pointe has exercised all reasonable professional care in preparing this information. The information has been obtained from sources we believe to be reliable; however, Beacon Pointe has not independently verified, or attested to, the accuracy or authenticity of the information. Nothing contained herein should be construed or relied upon as investment, legal or tax advice. All investments involve risks, including the loss of principal. Investors should consult with their financial professional before making any investment decisions. Past performance is not a guarantee of future results.

© Beacon Pointe Advisors. All Rights Reserved.

IMPORTANT NOTICE:

You are now leaving the website of Beacon Pointe Advisors and will be entering the website for Institutional Intelligent Portfolios®, an automated investment management service made available to you exclusively through Beacon Pointe Advisors. Beacon Pointe Advisors is independent of and not owned by, affiliated with, or sponsored or supervised by Schwab. Schwab has no responsibility for the content of Beacon Pointe Advisors' website. This link to the Institutional Intelligent Portfolios website should not be considered to be either a recommendation by SPT, Schwab, or any of their affiliates, or a solicitation of any offer to purchase or sell any security.

Privacy Preferences
When you visit our website, it may store information through your browser from specific services, usually in form of cookies. Here you can change your privacy preferences. Please note that blocking some types of cookies may impact your experience on our website and the services we offer.
Loading...