Required Minimum Distributions (RMDs) for Inherited IRAs

If you inherited a traditional or Roth IRA, you may be confused about the requirements for distributing funds from these accounts. Rules around inherited IRAs have shifted in the past few years, complicating the process. Additionally, there are different rules for several different classes of beneficiaries. However, following the rules of inherited IRAs can be important for avoiding tax penalties. Accordingly, if you have inherited an IRA recently or anticipate inheriting one in the future, familiarize yourself with the below classes of beneficiary as well as associated required minimum distribution (RMDs) rules for IRAs inherited in 2020 and beyond.

Classes of Beneficiary:

• Eligible Designated Beneficiary: An eligible designated beneficiary is the decedent’s spouse or minor child, someone who is permanently disabled or chronically ill, or someone who is no more than 10 years younger than the decedent. A minor child is an eligible designated beneficiary until they attain the age of 21, at which point they become a designated beneficiary and must switch to using withdrawal options available to designated beneficiaries. Spousal eligible designated beneficiaries have more withdrawal options than do other eligible designated beneficiaries.
• Designated Beneficiary: A designated beneficiary is any individual beneficiary who is not in one of the above eligible categories.
• Non-Individual or Unnamed Beneficiary: If the decedent does not name a beneficiary or leaves their assets to an estate, charity, or organization, there are different withdrawal requirements.

Withdrawal Option #1: Roll IRA assets into your own IRA. For traditional IRAs, you will then begin taking RMDs when you reach the required age, currently 73. You can take penalty-free withdrawals after you turn 59 1/2, and you can designate your own beneficiary.

• This option is best for individuals who do not have a current need for the IRA funds and want them to continue to grow tax-free.
• This option is available for spousal eligible designated beneficiaries of traditional and Roth IRAs. This option is only available if the decedent’s spouse is the only beneficiary of the IRA.

Withdrawal Option #2: Open an inherited IRA. You must begin taking RMDs at the later of 12/31 of the year following the decedent’s death or the year in which the decedent would have turned 73. Your RMDs will be calculated based upon your life expectancy, reevaluated each year.

• This option is best for spouses who want to begin taking RMDs when their deceased spouse would have turned 73, rather than when they themselves turn 73. This option is also best for non-spousal eligible designated beneficiaries who want to stretch out their IRA distributions.
• This option is available for spousal and non-spousal eligible designated beneficiaries of traditional and Roth IRAs.

Withdrawal Option #3: Lump sum distribution. You take out all of the funds at once. For a traditional IRA, you must pay tax on the entire distribution but it will be penalty-free. For a Roth IRA, the entire distribution is tax-free if the account has been open for at least 5 years. If the account has not been open for 5 years, earnings will be taxable.

• This option is best for individuals who have an immediate need for the funds and can incur the higher tax bill that comes with a sizable traditional IRA withdrawal.
• This option is available for all beneficiaries.

Withdrawal Option #4: Open an inherited IRA and distribute the funds by the end of the 10th year following the decedent’s death.

• This option is best for designated beneficiaries who do not want to take a lump sum distribution or eligible designated beneficiaries who want to receive the funds within the next decade but spread out the distributions.
• This option is available for designated beneficiaries, eligible designated beneficiaries of Roth IRAs, and eligible designated beneficiaries of traditional IRAs who inherited before the original account owner was required to take RMDs.
  • If the designated beneficiary opts for this method and inherits a traditional IRA after the account owner began taking RMDs, the designated beneficiary will be required to continue taking RMDs during the 10-year period.

Withdrawal Option #5: Non-individual beneficiaries, including estates, charities, and organizations, will be required to either take RMDs based on the original owner’s life expectancy or fully distribute the account by the end of the fifth year after the original owner’s passing. The second option is only available if the original owner died before being required to take RMDs.

• This option is available for non-individual beneficiaries.

As you navigate the inherited IRA landscape, do not hesitate to reach out to our financial planning team with any questions. We are happy to assist you in navigating the rules and associated tax and financial implications.