As we get older, it is likely that we might inherit an IRA from
mom or dad – or we need to counsel mom or dad as they inherit an IRA after one
of them dies. The rules are different in each scenario and due to the passage
of the SECURE Act, the rules have changed.
Thankfully, the Internal Revenue Service succinctly explains the
choices one has on how to treat an inherited IRA. Here are the choices, copied
(not summarized) directly from the IRS website:
“A beneficiary can be any person or entity the owner chooses to
receive the benefits of a retirement account or an IRA after he or she dies.
Beneficiaries of a retirement account or traditional IRA must include in their
gross income any taxable distributions they receive.
IRA Beneficiaries
Inherited from spouse. If a traditional IRA is
inherited from a spouse, the surviving spouse generally has the following three
choices:
1.
Treat it as his or her own IRA by
designating himself or herself as the account owner.
2.
Treat it as his or her own by
rolling it over into a traditional IRA, or to the extent it is
taxable, into
a.
Qualified employer plan,
b.
Qualified employee annuity plan
(section 403(a) plan),
c.
Tax-sheltered annuity plan
(section 403(b) plan),
d.
Deferred compensation plan of a
state or local government (section 457(b) plan), or
3.
Treat himself or herself as the
beneficiary rather than treating the IRA as his or her own.
If a surviving spouse receives a distribution from his or her
deceased spouse’s IRA, it can be rolled over into an IRA of the surviving
spouse within the 60-day time limit, as long as the distribution is not a
required distribution, even if the surviving spouse is not the sole beneficiary
of his or her deceased spouse’s IRA.
Inherited from someone other
than a spouse. If
the inherited traditional IRA is from anyone other than a deceased spouse, the
beneficiary cannot treat it as his or her own. This means that the beneficiary
cannot make any contributions to the IRA or roll over any amounts into or out
of the inherited IRA. However, the beneficiary can make a trustee-to-trustee
transfer as long as the IRA into which amounts are being moved is set up and
maintained in the name of the deceased IRA owner for the benefit of the
beneficiary.
Like the original owner, the beneficiary generally will not owe
tax on the assets in the IRA until he or she receives distributions from it.
Generally, the entire interest in a Roth IRA must
be distributed by the end of the fifth calendar year after the year of the
owner’s death unless the interest is payable to a designated beneficiary over
the life or life expectancy of the designated beneficiary.
If paid as an annuity, the entire interest must be payable over a
period not greater than the designated beneficiary’s life expectancy and
distributions must begin before the end of the calendar year following the year
of death. Distributions from another Roth IRA cannot be substituted for these
distributions unless the other Roth IRA was inherited from the same decedent.
If the sole beneficiary is the spouse, he or she can either delay
distributions until the decedent would have reached age 70½ or treat the Roth
IRA as his or her own.
For IRAs inherited from original owners who have passed away on or
after January 1, 2020, non-spousal beneficiaries are required to withdraw all
assets from an inherited IRA or 401(k) plan within 10 years following the death
of the account holder. 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.
Beneficiaries of Qualified
Plans
Generally, a beneficiary reports pension or annuity income in the
same way the plan participant would have reported it. However, some special
rules apply.
A beneficiary of an employee who was covered by a retirement plan
can exclude from income a portion of nonperiodic distributions received that
totally relieve the payer from the obligation to pay an annuity. The amount
that the beneficiary can exclude is equal to the deceased employee’s investment
in the contract (cost).
If the beneficiary is entitled to receive a survivor annuity on
the death of an employee, the beneficiary can exclude part of each annuity
payment as a tax-free recovery of the employee’s investment in the contract.
The beneficiary must figure the tax-free part of each payment using the method
that applies as if he or she were the employee.
Benefits paid to a survivor under a joint and survivor annuity
must be included in the surviving spouse’s gross income in the same way the
retiree would have included them in gross income.”
What Should You Do?
Consulting your financial professional for guidance, especially to
confirm that the decisions you make are consistent with your overall financial
plan, is a good idea.
