If you’ve recently received an inheritance with assets that include a traditional or Roth IRA, you have some strategizing to do. In other words, don’t just take the money and run. There are different withdrawal rules depending on your relationship with the deceased, how old they were when they died, and the type of IRA you’ve inherited. How and when you withdraw the money could have significant tax consequences.
The 10-Year Rule
At the end of 2019, the SECURE Act changed the rules for beneficiaries of traditional and Roth IRAs, making it so that beneficiaries must empty the account within 10 years. This does not apply to spouses, minor children of the deceased, the chronically ill or disabled, or those who are not more than 10 years younger than the original owner (these groups are called Eligible Designated Beneficiaries (EDBs)).
For anyone else, if you fail to be strategic about withdrawals, you could be forced to empty the entire account at once with 10 years’ worth of growth. The problem with that is that it would greatly increase your taxable income for the year, pushing you into a higher tax bracket and subjecting you to added taxes, like the Medicare surcharge tax.
A Summary of Distribution Options
Since the type of account, when it was inherited, and who is inheriting changes your available options, here’s a breakdown of what you can do as a beneficiary of a Roth IRA.
For the Spouse
Your first option is to transfer the funds into your own IRA as a spousal transfer, and thus become the owner rather than the inheritor (this is only true if you are the sole beneficiary).
Or you can choose to open an Inherited IRA with two methods: Life Expectancy or 5-year. With the Life Expectancy option, you can postpone taking distributions until either the date your spouse would have turned 72 or December 31st of the year following the year they died, whichever comes later. When they start, they are spread out over the surviving spouse’s life expectancy.
With the 5-year option, the distributed money is only spread out over 5 years, with the final withdrawal happening by December 31st of the fifth year after the year of the spouse’s death.
Finally, you could opt for a lump-sum payment of the funds.
Other Eligible Designated Beneficiaries
If you’re anyone other than the spouse, your options are a bit more limited. You can choose one of the Inherited IRA Life Expectancy or 5-year options or take a lump-sum payment. While this is similar to the surviving spouse’s choices, there are some differences with the Life Expectancy option based on the age of the deceased. Be sure to talk through every detail with an experienced financial professional before choosing.
If you don’t fall into one of the EDB categories, you are subject to the 10-year rule. While this cuts down on your decision-making, you still have control over how much you take and at what time during those 10 years to minimize tax liability.
We Can Guide You Through
That was a lot. If your head is spinning with all the nuances and details of the rules that apply to beneficiaries of traditional or Roth IRAs, we can help. Everyone’s situation is unique and your circumstances will dictate which choice is best for you and your money. If you have inherited an IRA or have any questions, please don’t hesitate to reach out to us at 559-440-6999 or by email at firstname.lastname@example.org.
T. Matthew Nichols is founder, CEO, and wealth advisor at Nichols Financial Strategies with more than 20 years of experience in the financial industry. He spends his days serving business owners and families, specializing in helping those in the agriculture industry proactively prepare for the unique challenges they face in a rapidly changing economy. Matt is an Accredited Investment Fiduciary® (AIF®) and holds his FINRA Series 7 and 63 securities registrations with LPL Financial and his California State Life & Health Insurance license. He’s also pursuing his ChFC designation and is dedicated to continuing his education and staying abreast of the latest financial trends and strategies. Matt’s mission is to help his clients transfer wealth from one generation to the next and work toward achieving their goals so they can spend more time on what they love most. Matt was born and raised in the California Central Valley and resides in Fresno with his wife, Christy, and their two daughters, Holly and Jillian. He enjoys golf, traveling, skiing, and spending quality time with his family. To learn more about Matt, connect with him on LinkedIn.