The rules around inherited retirement accounts all changed after the passage of the SECURE Act and the SECURE 2.0 Act, so now you have more flexibility in when to take money from the inherited account. In order to receive flexibility in tax treatment, you need to establish an inherited IRA and transfer the funds there. If you take the funds as a transfer to your bank account (or the bank account of a trust), then the entire distribution is taxed in that one year. Since US tax rates are progressive, having more income in that one year means you will likely pay a higher tax rate than if you spread the distributions over multiple years, as the tax code allows. 

Improper planning around inherited retirement accounts can result in an unexpected tax liability. To understand these rules, you must understand the following terms: retirement account, eligible designated beneficiary, non-eligible designated beneficiary, required minimum distribution, and required beginning date. We will try to clear up any confusion around these terms below, as well as answer common questions surrounding inherited IRAs and inherited retirement accounts in general. 

Successor beneficiaries (i.e., those inheriting an inherited IRA) and trust beneficiaries are beyond the scope of this blog. 

What is a retirement plan account? 

Retirement plan accounts are defined as including 401(k)s, 403(b)s, and TSPs. Note that rules for inherited IRAs/SEP-IRAs and SIMPLE IRAs are usually different from those for retirement plan accounts. 

What is an eligible designated beneficiary?

An eligible designated beneficiary is a named beneficiary (listed on a beneficiary designation form) who is a spouse, a minor child, a disabled person, a chronically ill person, a person not more than 10 years younger than the decedent, or a specific kind of trust that benefits someone who meets one of these criteria.  

How is a minor child defined?

A minor child is defined as a child younger than age 21, regardless of state law. 

What documentation does a disabled or chronically ill beneficiary need to provide and by when?

This requirement only applies to retirement plan accounts. IRA beneficiaries do not need to provide documentation. 

Disabled or chronically ill beneficiaries must provide proof to the plan administrator by October 31 of the year following the year of the death. 

Disability documentation includes a Social Security disability determination letter or a physical letter confirming the beneficiary’s inability to perform substantially gainful activity due to a long-continued and indefinite impairment. 

Chronically ill documentation includes a certification from a licensed health care professional documenting that the beneficiary is unable to perform at least two activities of daily living without substantial assistance and that the condition is lengthy and indefinite. 

What is a non-eligible designated beneficiary?

A non-eligible designated beneficiary is a named beneficiary who is not an eligible designated beneficiary. Basically, it’s a non-spouse who is more than 10 years younger than the decedent but not their minor child and not disabled or chronically ill. 

What is a required minimum distribution?

A required minimum distribution (RMD) is the amount the IRA/401(k)/403(b)/TSP or inherited IRA/401(k)/403(b)/TSP owner must remove from the account annually. 

What is the required beginning date?

The required beginning date (RBD) is the date on which the decedent is required to start their RMD. This is now age 73, and it increases to age 75 for people born after December 31, 1959.  

Does a spouse have to take an RMD?

A spouse is considered an eligible designated beneficiary if they were listed as a beneficiary on the account. Spouses are allowed to add the inherited retirement account to their own IRA or keep it in an inherited IRA. If it is in an inherited IRA, they may need to take an RMD if the decedent died after their RBD. If the spouse adds the account to their own IRA, no RMD is required until the spouse turns age 73/75. 

If the inheriting spouse is under age 59 1/2 and there is any chance they might need the money before age 59 1/2, they should set up an inherited IRA instead of rolling it into their own IRA, so they can avoid a penalty on withdrawals. For a spouse who inherits an IRA or other retirement account, it’s a good idea to speak with a fee-only financial advisor to get fiduciary advice about your options. 

One potential pitfall in spousal inherited IRA planning is that if the spouse decided to treat the account as an inherited IRA to be emptied over 10 years without any RMDs (since the decedent died before their RBD) and then later adds it to their own IRA, they will have to make up any RMDs that would have been due if they had added it to their own IRA upon inheriting it, before rolling it over. This is only if the spouse adds the account to their own IRA after their own RBD, so it will rarely apply, but it can be a trap for the unwary! 

Do I have to take a distribution from the inherited (non-Roth) account?

This depends on whether the decedent died before or after their RBD and whether you are the spouse of the decedent. See above if you are the spouse of the decedent. If you are not the spouse of the decedent and the decedent died after their RBD, then you must take an RMD each year.  

A non-eligible designated beneficiary must also empty the account within 10 years of the year after the date of death (see below). This can be confusing, as the account is subject to two requirements at once: taking RMDs each year and distributing the entire account within 10 years. 

What were the old “stretch” rules for inherited IRA distributions?

Prior to the SECURE Act, most beneficiaries were able to take RMDs over their own life expectancy. This allowed younger beneficiaries to stretch the IRA income over a longer time period. This option is now only available to eligible designated beneficiaries.  

What is the 10-year rule?

The 10-year rule requires you to empty the inherited retirement account by 10 years following the year of the death. For example, if the decedent died on January 20, 2024, you have until December 31, 2034, to empty the account. If the decedent died after their RBD, you will also need to take an RMD each year during this 10-year period. Distribution amounts may vary substantially each year during this 10-year period, but the RMD sets a floor for the amount that must be taken out each year.  

What if the account is a Roth?

With one exception, no RMDs are required from a Roth account, no matter who inherits it. Inherited Roth retirement plan accounts and IRAs still need to be emptied within five or 10 years, but you can wait until the final year to do so, to allow the account to continue to compound tax-free. 

If the decedent died after their RBD and their retirement plan account consists of Roth and non-Roth portions, it is subject to RMDs, but the distribution from the Roth is not taxable. This is a reason to roll the retirement account to an IRA while the decedent is still alive, if they are no longer working for the employer sponsoring the plan. No RMDs apply to inherited Roth IRAs. 

Do I have to empty the account within 10 years?

You may need to empty the account over 10 years if you are an eligible designated beneficiary. Retirement plans such as 401k, TSPs and 403bs can choose between following the 10-year rule or the old stretch rules after death for eligible designated beneficiaries. Your plan document should document this. 

If the account is an IRA, then you must empty the account by the 10th year following the year of death if you are a non-eligible designated beneficiary.  

How are distributions from inherited retirement accounts taxed?

For the most part, inherited retirement account distributions are taxed the same way the original owner would have been taxed. As money is withdrawn from an inherited IRA, it is taxed at the individual’s income tax rate. Roth IRAs are withdrawn tax-free, the same as if the original owner had withdrawn them. A key difference, however, is that the 10% early withdrawal penalty is waived. So even if you are under the early retirement distribution age of 59 1/2, you can withdraw money out of the inherited IRA without having to worry about getting slapped with a penalty. 

What about non-designated beneficiaries?

An important consideration is that all of the above assumes you were a named beneficiary on the account. Accounts without beneficiary designations will pass through probate and are subject to different rules.  

If the decedent died before their RBD, then the account must be emptied within five years after the year after the date of the death, but the assets can be withdrawn at any time over those five years. 

If the decedent died after their RBD, then the account must continue RMDs over the decedent’s life expectancy. This provides an odd planning opportunity, since if the decedent was between the ages of 75 and 80, their remaining life expectancy is longer than 10 years, and the beneficiary will have a longer time over which to empty the account! Obtaining this tax treatment will mean letting the account pass through probate, which is an expensive, time-consuming, and public process. 

How do I calculate the RMD?

The IRS determines a divisor based on your age that determines the RMD. The divisor is based on certain IRS tables. The younger you are, the smaller the percentage that is required to be removed from the account. For help in calculating the distribution amount, it is best to speak with a financial advisor or accountant.  

If an RMD is required, make sure that you take the RMD from the inherited IRA in the year after the original account owner died. Failure to take RMDs can subject you to a penalty of the amount that was supposed to be distributed.  

It is important to note that the IRS extended the waiver for taking RMDs so that the first year for an RMD on an account inherited after January 1, 2020, is 2025. 

Transfer carefully 

One thing to be mindful of when transferring inherited IRAs from one financial institution to another is that if you withdraw money from the account, it cannot be redeposited. Owners of IRAs (non-inherited) have the ability to withdraw funds once every rolling 12 months, and as long as they are redeposited in another like account within 60 days, the funds are considered a rollover and not taxable. This exception does not apply to inherited IRAs (or any other retirement account), and once the money is taken out, it’s taxable.  

The good news is that inherited IRAs can be moved from one financial institution to another; they just have to go directly (this is known as a “trustee-to-trustee transfer”). For instance, if you have an account at Vanguard and want to move it to Fidelity, this can be done by completing a transfer-of-assets request. That way the funds move from one account to the other without leaving the IRA. 

Summary

If you inherit an IRA or other retirement account, you want to: 

1. Avoid cashing out the account without understanding the tax consequences 
2. Understand the differences between RMD, RBD, eligible and non-eligible designated beneficiaries, and non-designated beneficiaries 

Inherited non-Roth retirement accounts are required to be distributed and taxed to you over five or 10 years or over your life expectancy. There are many factors that determine this, and while this blog was a good primer, we suggest you meet with one of our financial advisors, who can determine the best course of action for your specific situation.