Inherited IRA Withdrawal Rules

Have you inherited an IRA from someone? Most retirement planning discussions center around our own IRAs and how to maximize our saving and investing. But with 401(k)s and IRAs becoming the main retirement savings vehicles for most people, there’s a good chance we will all also inherit an IRA at some point. 

When you inherit an IRA you get to keep the tax deferred status, and if you cash it out immediately, you’ll be taxed at ordinary income rates. Thankfully, you are not required to cash it out immediately. When you have to start taking money out depends on your relationship to the original owner and if they had started their required distributions or not. 

The simplest and most advantageous way to inherit an IRA is from your spouse. Spouses are able to roll over inherited IRAs into their own IRA and have them treated as their own. So if you haven’t yet reached the required minimum distribution age, you can continue to delay withdrawals. One note, if your spouse had already reached RMD age but had not taken it for the year in which they passed you’re still required to take their distribution for that year. Also, if your spouse had already started RMDs, but you’re under 59.5 and need the income you may consider rolling it into an Inherited IRA as opposed to your own so you can continue taking RMDs penalty free. 

The rules if you inherit an IRA from someone that is not your spouse are a little different. Since these are tax deferred dollars, the IRS wants you to start making withdrawals so that they can begin collecting the tax revenue. 

There are two main types of beneficiaries of IRAs. Eligible and Non-Eligible Designated Beneficiaries. Eligible Designated Beneficiaries include Spouses, the owner’s child who is under 18, a disabled individual, a chronically ill-individual, and any one else not more than 10 years younger than the owner. 

As an eligible designated beneficiary, you are able to stretch the distributions over your remaining lifetime. In 2019, congress passed the SECURE Act which changed the rules for non-eligible designated beneficiaries. 

The SECURE ACT introduced the 10-year rule for all non-eligible designated beneficiaries. The new rule required that the account must be liquidated by the end of the 10th year following the year of death. 

While sounding relatively straight forward this has created some confusion for the last few years, as the rule was originally read to mean you could delay taking any distribution until the 10th year if you so choose. But in 2022 the IRS released new proposed regulations that stipulated that if the original owner had reached the age of required distributions that beneficiaries would be required to follow the stretch RMD rules as well as the 10 year rule. 

Now due to the confusion around this the IRS has waived the stretch RMD requirements for 2021 - 2024, but starting in 2025 you’ll be required to satisfy the stretch RMD if you inherited an IRA as a non-eligible designated beneficiary after 2020. 

So those are the new rules, but in most cases it will be smart to take out more than the RMD in years 1-9 to avoid having to take a very large distribution in year 10. This could mean that you take roughly equal distributions to ensure it's empty by the end of year 10, or if you know income may be lower in one or more of the next 10 years, you may take only the RMD in the higher income years and take larger distributions in the lower income years. 

Inheritances can often times feel like “found money” if you were never really counting on them, but due to the complicated tax rules, it is important to ensure that you’re incorporating them into your overall tax plan to ensure that you don’t wind of paying more in taxes (or penalties if you miss distributions) than necessary. 

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