Inherited IRA RMD

IRA assets cannot be left in an IRA forever. You know that – as many of our retired clients take an annual Required Minimum Distribution (RMD).  Where it gets complicated, especially with recent SECURE Act guidance, is when you inherit an IRA. Not only do we help clients navigate these complex rules, we do it with tax efficiency at the forefront.

Before the SECURE Act was passed on December 20, 2019, beneficiaries who inherited an IRA from someone other than their spouse were required to use an IRS table to calculate how much they had to withdraw annually from the inherited IRA. They had the ability to “stretch” out RMD payments over their lifetime. Now, with the SECURE Act in place, there is a 10-year rule, meaning that ALL inherited money from an IRA MUST be withdrawn within 10 years from the death of the original IRA owner. This rule went into effect for deaths beginning in 2020.

For the past few years, there was some confusion over HOW the 10-year withdrawal was required to be done. Did beneficiaries of inherited IRAs have to take 1/10th of the IRA’s value as an RMD each year? Was any RMD, at all, required before the 10th year? The IRS was silent in terms of guidance until just a few months back.

On July 18, 2024, the IRS issued some clarification on RMDs for beneficiaries of qualified plans, including IRAs. See the IRA Beneficiary flow chart below explaining the options for beneficiaries of qualified plans below. Because you work with us, you don’t need to be conversant in the guidance. You do need to know that we will discuss options with you, especially since there are tax implications.

Source: Kitces.com, August 2024

If you are wondering how decisions around taking inherited IRA RMDs impacts your tax situation, here are a few examples.

Let’s consider a client who inherited an IRA from their mother, and who will be retiring in two years. While they are working, they don’t have a lot of control over their income as they earn a salary. If they are considered a Non-Eligible Designated Beneficiary and their mom died before her Required Beginning Date, they have the option to take money at any point, if it all comes out of the account by the end of the 10 years, (see “Designated Beneficiary” diagram).

Source: Kitces.com, August 2024

They can use this opportunity to delay withdrawals until they they are retired, and then take money out of the inherited IRA when they are retired. In this way, they won’t have to worry about extra IRA withdrawals during their working  years, which would have potentially pushed them into a higher tax bracket. It could mean the difference between being in the 12% tax bracket vs. the 22% tax bracket.

Now let’s consider that the same client, who inherited an IRA from their mom, is not planning to retire any time soon. If they follow a standard internet calculator to determine the RMD needed for their 10-year withdrawal period, it will essentially require her to withdraw a small amount for years 1-9, and then the bulk of the money in year 10. If they only withdraw the required amount, they will be stuck with a large balloon payment in year 10. This could easily push them into a higher tax bracket in year 10. Instead, they could consider withdrawing more money in years 1-9, so that they won’t have the large taxable distribution to contend with in year 10 and can effectively manage their tax bracket along the way.

These are just two examples of many. On the flip side, there is planning for your IRA to BE inherited by your loved ones. There are ways to mitigate taxes there as well. We love helping clients navigate tax planning, so please do not hesitate to ask us about this if you have an IRA or an inherited IRA.

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