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What You Need To Know About Inheriting an IRA

If you inherit an IRA or a 401k, there are some rules in place that will ultimately require you to take the money out and pay taxes on it. The SECURE Act of 2019 has provisions that affect required minimum distributions, or RMDs. Do any of those rules apply to you? Here are some things you need to know. 

Surviving Spouses and Non-Spouses

First, if you’re a surviving spouse, as the IRA inheritor, you have some flexibility. Typically you can either transfer the assets to your own IRA, where you then become the new owner, but keep in mind that if you make yourself the new owner and you’re under age 59½ and you need to access the money, you’ll have to pay a 10% early withdrawal penalty. Or you can simply treat it as an inherited IRA, where it remains in your spouse’s name and there are no RMDs until that spouse would have been age 72 or older. With this option there are no penalties for distributions before you reach age 59 ½.  

That’s just for spouses. For non-spouses, the rules are different; and somewhat complicated. 

When you inherit an IRA, as a non-spouse, you’ll have a required minimum distribution on that inherited IRA, even if you’re nowhere near the normal RMD age of 72, and this includes Roth IRAs. 

Rollovers and Withdrawals

Also, you’re not allowed to transfer or rollover funds from an inherited IRA directly into your own IRA. When you distribute funds for any reason, it’s like getting a check payable to you, and it’s a taxable distribution. You also can’t do a 60-day rollover with inherited IRA funds, nor can you convert them to a Roth. Yes, the rules are tight. 

On the other hand, there is no 10% early withdrawal penalty on an inherited IRA. You’ll be taxed on any funds you take out (unless it’s a qualified Roth distribution), but you won’t be charged a penalty. 

Now here’s where it starts to become even more complex. 

And now for the complex info…

If the IRA owner died prior to 2020 and they had not reached RMD age yet, then you have two options as the non-spouse beneficiary: First option is you can take an RMD every year starting the year after the IRA owner died based on your life expectancy and stretch it out over that period of years until it’s gone.   

The second option is to completely distribute the IRA — in other words, take all the money out — by the end of the 5th tax year after the owner’s death. Normally, this option is only used when the beneficiary misses the first beneficiary RMD. So once you miss an RMD in the first few years, then the entire IRA must be distributed within that five year window.  

But if the person who died WAS of RMD age – then there’s no five-year option. You MUST take an RMD out every single year or you’ll be assessed a penalty for missing it. – and the penalty is 50% of the shortfall. 

Okay: but what if the owner of the IRA died in 2020 or later? Well, the Secure Act changed things for non-spouse beneficiaries. Most non-spouse beneficiaries no longer have the lifetime “Stretch” option.  In most cases, the entire IRA will need to be distributed by the end of the 10th tax year after the owner’s death. You can take out as much or as little as you want in years 1-9 as long as 100% of the money is distributed by the end of the 10th year.   

Now,  this 10 year clock doesn’t begin for a beneficiary who is a minor until they reach age 18.  And these new “no-stretch” rules don’t apply to beneficiaries who are less than 10 years younger than the owner, or to beneficiaries who have a chronic illness, or who are disabled (as defined by the IRS). 

Hey, we told you it was complicated!

But complicated or not, making mistakes or violating the rules could create more taxes and penalties for you. This is why it’s really important that you have someone advising you who is familiar with the rules, benefits, and consequences of all the various scenarios.   

At Lucia Capital Group, we do things like this every single day. If you’re in a situation where you’re inheriting taxable assets, it’s a really good idea to talk it over with one of our advisors so we can help you avoid paying any unnecessary taxes and penalties.  How can we help you?  Just give us a call! 

Important Information:

The information provided should not be considered specific tax, legal, or investment advice and is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.

Different types of investments and/or investment strategies involve varying levels of risk, and there can be no assurance that any specific investment or investment strategy (including the investments purchased and/or investment strategies devised by Lucia Capital Group (“LCG”)) will be either suitable or profitable for a client's or prospective client's portfolio, thus, investments may result in a loss of principal. Accordingly, no client or prospective client should assume that the presentation (or any component thereof) serves as the receipt of, or a substitute for, personalized advice from LCG or from any other investment professional.

You should always seek counsel of the appropriate advisor prior to making any investment decision. All investments are subject to risk including the loss of principal. This material was gathered from sources believed to be reliable, however, its accuracy cannot be guaranteed.

Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.

IRA withdrawals will be taxed at ordinary income rates. Withdrawals prior to age 59½ may also be subject to a 10% penalty tax.

Roth IRA distributions of principal from a Roth IRA are tax-free; however, any earnings will be taxed at ordinary income rates and a 10% penalty tax will apply if withdrawn prior to age 59½ or within five years of the date the Roth IRA was established, whichever is longer.

Rick Plum is a registered representative with, and securities and advisory services offered through LPL Financial, a registered investment advisor and member FINRA/SIPC. The investment professionals are affiliated with LPL Financial and are conducting business using the name Lucia Capital Group, a separate entity from LPL Financial.

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