Inheriting an Inherited IRA

Mom had an IRA. She died and her son became the beneficiary of the Inherited IRA. Before the IRA was depleted, son dies. Now his daughter is the beneficiary. While it is wonderful that three generations benefit from the IRA, the rules dictating the distribution of funds from the Inherited IRA are very complex.

It feels just like yesterday the SECURE Act passed, changing the distribution requirements for the beneficiaries of Inherited IRAs. But the time has come when we are starting to see the ripple effects of these changes, specifically when it comes to inheriting these inherited IRAs.

As a refresher, some of the most notable changes that the SECURE Act enacted starting 1/1/2020 were eliminating the “stretch” provision for non-eligible beneficiaries and creating the 10-year rule.

Eligible beneficiaries include the spouse of the decedent, minor children of the decedent, a person less than 10 years younger than the decedent, and disabled or chronically ill individuals. People in these categories can still stretch their required distributions. Specifically, suppose the original owner died before their Required Beginning Date (the age Required Minimum Distributions commence). In that case, the beneficiary can choose between the stretch and the 10-Year Rule (often, the stretch is the more favorable option, given you can spread the tax burden out over a longer period of time). If the original account owner died after their Required Beginning Date, the beneficiary can stretch their distributions over the longer of their own life expectancy or the decedent’s life.

If you don't fall into one of the above categories, you're likely considered a non-eligible beneficiary and face more complex distribution requirements. Suppose the original owner died prior to their Required Beginning Date. In that case, the beneficiary is subject to the 10-year rule, which means the entire account must be depleted within 10 years of inheriting it. If the original account owner died after their Required Beginning Date, the beneficiary will be subject to the 10-year rule and annual RMDs.

In summary, beneficiaries' distribution rules largely depend on their relationship with the original owner and when the original owner died.

Now, what happens if the beneficiary dies and there are still funds in the account? What distribution requirements will the successor beneficiary be subject to? It will depend on several, even more complex, factors:

• Whether the account owner died before or after the SECURE Act became effective,
  
  
• Whether the original beneficiary died before or after the SECURE Act became effective,
  
  
• Whether the original beneficiary was an eligible designated beneficiary or a non-eligible designated beneficiary, and
  
  
• Whether the account owner died before or after their Required Beginning Date (RBD)
  
  

Example #1: Account Owner Died Before the SECURE Act Became Effective

1a: Beneficiary Also Died Before the SECURE Act Became Effective

If Grandma died prior to 1/1/2020 and her adult son was the beneficiary of her IRA, he could stretch distributions out over his lifetime. If he also dies before 1/1/2020 and his wife is the beneficiary, she must continue taking annual RMDs based on the son’s life expectancy.

1b: Beneficiary Died After the SECURE Act Became Effective

If Grandma died prior to 1/1/2020 and her adult son was the beneficiary of her IRA, he could stretch distributions out over his lifetime. If he passes away after 1/1/2020 and his wife is the beneficiary, the wife must continue the annual RMDs in addition to depleting the account within 10 years.

Example #2: Account Owner Died After the SECURE Act Became Effective & Left the Account to an Eligible Designated Beneficiary

2a: Account Owner Died Prior to Their Required Beginning Date

If mom (age 65) died after 1/1/2020 and her disabled daughter (who meets the IRS’ definition of disabled) was the beneficiary of her IRA. In that case, she is considered an eligible beneficiary and can choose between the stretch provision or the 10-year rule. When the daughter passes away 6 years later, and her brother is the beneficiary, his distribution requirements will be dependent on the original beneficiary’s distribution method. If she chooses the stretch provision, the brother must continue annual RMDs based on the daughter’s life expectancy and deplete the account within 10 years of inheriting it. If she chose the 10-year rule instead, the brother has 4 years to finish out the initial 10-year period.

2b: Account Owner Died After Their Required Beginning Date

If Grandma (age 80) died after 1/1/2020 and her best friend (age 75) was the beneficiary of her IRA, she is considered an eligible beneficiary (less than 10 years younger than the owner) and can stretch distributions out over her lifetime. When the best friend passes away, and her son is the beneficiary, he must continue annual RMDs based on the best friend’s life expectancy and distribute the account within 10 years.

Example #3: Account Owner Died After the SECURE Act Became Effective & Left the Account to a Non-Eligible Designated Beneficiary

3a: Account Owner Died Prior to Their Required Beginning Date

If mom (age 65) died after 1/1/2020 and her adult daughter was the beneficiary of her IRA, she is considered a non-eligible beneficiary and has 10 years to distribute the account. If she passes away 8 years into the 10-year window and her husband is the beneficiary, the husband only has 2 more years to deplete the account.

3b: Account Owner Died After Their Required Beginning Date

If Grandma (age 80) died after 1/1/2020 and her adult daughter was the beneficiary of her IRA, she is considered a non-eligible beneficiary and will be subject to annual RMDs and the 10-year rule. If she passes away 8 years into the 10-year window and her husband is the beneficiary, the husband must continue annual RMDs in addition to depleting the account within 2 years.

Summary

These are some of the most common scenarios when inheriting an inherited IRA, but your situation might be unique. Reach out to your Financial Advisor to help decipher these rules and make sure you’re meeting your distribution requirements in a tax-efficient manner.

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