Inherited IRA Planning

The 2019 SECURE Act updated rules previously allowing inherited IRA distributions to be extended over the beneficiary’s lifetime. 

Under the SECURE Act, the general rule is the beneficiary of inherited IRAs of decedents dying after December 31, 2019, “must withdraw the entire account by the tenth calendar year following the year” of the decedent’s date of death. The ten-year rule does not apply to designated individuals who are the surviving spouse of the deceased account owner, disabled or chronically ill individuals, minor children, or individuals who are not more than ten years younger than the deceased account owner. There are also certain types of trusts established for individuals with disabilities or chronic illnesses qualifying as exceptions to the general rule. 

A surviving spouse of a deceased account owner can delay receiving distributions until the later of the surviving spouse’s required beginning date to receive required minimum distributions (RMDs) or the year the deceased spouse would have turned age 72. At that time, the surviving spouse must take distributions based on his or her life expectancy. So, not only can a surviving spouse extend distributions, but he or she can also potentially delay receiving distributions.

Individuals with disabilities or chronic illnesses (or certain trusts established for individuals with disabilities or chronic illnesses), and individuals who are not more than ten years younger than the deceased account owner can choose to extend distributions over their lifetime. Unlike surviving spouses, they do not have the ability to delay receiving distributions.

A minor child of the deceased account owner, who is a designated beneficiary of an inherited IRA, can choose to use his or her life expectancy to calculate the RMD each year until they reach the age of majority (age 18 in most states). Upon reaching the age of majority, the child will need to withdraw the entire account balance within ten years.

In proposed guidance released in February of 2022, the IRS indicated that for designated beneficiaries subject to the ten-year rule, if the deceased account owner was subject to the required minimum distribution rules, then the designated beneficiary would also be required to take annual distributions. The IRS is still reviewing this proposal and is expected to issue its final guidance in 2023. 

For traditional IRAs and 401ks, all distributions are taxed to the recipient as ordinary income. As such, if a designated beneficiary receives a substantial distribution, the required distributions could potentially put them in a significantly higher tax bracket. Before the IRS issued its proposed guidance in February, considerable consideration was placed on tax planning around these distributions.  For beneficiaries who were still working but reaching retirement age within ten years, those individuals may have decided to hold off on receiving any distributions until retirement when they would have little to no earned income. The income generated from the retirement distribution would have likely been taxed at a lower tax bracket since the beneficiary would have experienced a dramatic decrease in his or her overall taxable income. 

For some expecting steady taxable income over the next ten years, a better tax strategy could be to take distributions each year over the ten-year payout period. Lower payouts over several years could potentially have less of an impact on tax brackets than receiving much larger sums over a shorter period of time. 


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