If you are the beneficiary of an IRA or 401(k) account, you will need to familiarize yourself with the rules of how you handle the account. After the passage of the 2019 Secure Act, the beneficiary must first determine the category of relationship to the person who died. Typically, the rules for required minimum distributions (RMDs) have three categories: spouses, non-spouses, and minors/entities. The IRS requires you to take the RMDs from your account or else you will be subject to a 50% IRS penalty of the RMD amount. Please note that distributions made from an IRA or inherited IRA are taxed at your current income tax rate.
If you are the surviving spouse, you have two options.
The first option is to roll the account into your own IRA and follow the standard RMD rules. You do not have to distribute your IRA until you reach RMD age, which is 72. However, in choosing this option, you become subject to the 10% early-withdrawal penalty if you withdraw funds before you turn 59 ½ years old. For most people who do not need to use the account for income, this is often the best option.
The second option is to open an inherited IRA, which is sometimes called a beneficiary IRA. This might be helpful if you are younger than 59 ½ and wish to avoid the early-withdrawal penalty for withdrawals you know you will need before age 59 ½. With this option, you can either distribute the account within 5 years, following the year of death or distribute it based on the IRS life expectancy table. The spouse must begin taking RMDs by the later of December 31 of the year after the owner’s death or December 31 of the year the owner would have reached RMD age. If decedent’s RMD has already begun, then the RMD amounts will be calculated based on your age and recalculated each year based on the IRS factors. If decedent’s RMD had not yet begun, then you can postpone your RMDs until when your spouse would have turned 72.
If you are a non-spouse beneficiary of an IRA or 401(k) plan, you will have to move the money/assets into an inherited IRA and follow the 10-year depletion rule. The 10-year depletion rule means the non-spouse beneficiary must withdraw all the funds within 10 years following the death of the original owner or he/she is subject to the IRS 50% penalty on the RMD amount. The 10-year rule allows the non-spouse beneficiaries to make decisions based on their anticipated tax bracket each year because withdrawals, also called distributions, are taxed at the current income tax rate. This is particularly advantageous to high income earners with fluctuating income. The exception to this 10-year depletion rule is if you are an eligible beneficiary: a minor, disabled or chronically ill individual, or an individual not more than 10 years younger than the original owner.
If the beneficiary is an entity, for instance an estate, trust, or charity, then the money/assets will have to moved to an inherited IRA. The timing of when the RMDs will be distributed from the inherited IRA will depend on the age of the deceased owner. If the decease owner reached 72 years old, then the distributions would be based on the remaining life expectancy of the deceased IRA owner. If the deceased IRA owner was younger than 72 then the assets must be completely distributed by December 31 of the 5th year following the death of the owner.
The Minor Child of the Decedent
If you are the minor child of the decedent, you will need to establish an inherited IRA. The minor child has one set of rules before turning age of majority, which is 18 in most states, and a different set of rules afterwards. Before reaching the age of majority, the minor child must take RMDs based on the minor child’s own life expectancy. After turning 18, the child then switches over to the 10-year depletion rule.
Seek Professional Advice
It is always recommended that you meet with your financial advisor to make sure you understand the rules and that you are making tax-efficient distribution plans. As you are aware, IRAs and 401(k) plans are funded with pre-tax dollars and allowed to grow tax-free. The 2019 Secure Act clarifies the schedule and manner for those dollars to be distributed and taxed. We are happy to assist you with the process.