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Inherited IRAs

Inherited IRAs

In the first quarter of 2023, Americans held more than $12 trillion in Individual Retirement Accounts (IRAs). Have you inherited some of that wealth? If so, there is a lot you need to know. The rules surrounding inherited IRAs can be confusing, but understanding them is crucial to making the most of your inheritance.

Join Matt Robison and I this week as we do a shallow dive into the deep world of inherited IRAs. Every situation is unique, so there is no one-size-fits-all answer, but we try to at least provide considerations that most people should be mindful of when deciding what to do with an inherited IRA.

Where to start with an inherited IRA: Eligible Designated Beneficiaries

If you inherited the IRA from a parent, you are probably not considered an Eligible Designated Beneficiary (EDB). There are five classes of EDBs:

  1. Spouse
  2. Minor child of the account owner (but not grandchild)
  3. Disabled individual
  4. Chronically ill individual
  5. An individual not more than 10 years younger than the IRA owner

These beneficiaries can distribute the IRA over their lifetime. For everyone else…

Secure 1.0 Act: Distributions are within 10 years

The Secure Act 1.0, established in 2019, changed the rules for inherited IRAs. For beneficiaries of IRA owners who died after 2019, the 10-year rule now applies. This means the inherited IRA must be fully distributed by the end of the 10th year following the year the account owner died.

Initially, many believed they could wait until the 10th year to take distributions. However, the IRS clarified that if the original owner was already taking required minimum distributions (RMDs), beneficiaries must continue taking RMDs based on the single life expectancy table. Due to confusion, the IRS waived penalties for missed RMDs in 2021, 2022, 2023, and now again in 2024.

Should you take Required Minimum Distributions in 2024?

Deciding whether to take distributions in 2024 depends on your financial situation:

  1. If you wait until the 10th year to take the entire distribution, it could bump you into a higher tax bracket. Taking it over time might be a better solution if you are close to the bracket limits.
  2. If you know you are going to have a low income year, ie. you intend to take a year off from work, this would be a great time to take a larger distribution.
  3. If you know you are going to have a high-income year, a large bonus, for example, or the sale of assets, you will probably want to only take the RMD or none to minimize your tax impact.

Consider AGI: Student Loans and other Factors

Be mindful of how distributions might affect your Adjusted Gross Income (AGI), especially if you’re on income-driven repayment plans for student loans or seeking Public Service Loan Forgiveness (PSLF).

Recall that any distributions from an Inherited Traditional IRA will count as income and therefore show up on your tax return.  Yes, you’ll owe tax on the income.  It also will add to your AGI, which is used for many tax calculations, including the following:

  1. Earned Income Tax Credit (EITC)
  2. Child Tax Credit
  3. Education Credits (such as the American Opportunity Credit and Lifetime Learning Credit)
  4. Retirement Savings Contributions Credit
  5. Deduction for Student Loan Interest
  6. And more…

Other Frequently Asked Questions about Inherited IRAs

  1. Are Roth IRAs included? Yes. While Roth IRA owners don’t have RMDs during their lifetime, their beneficiaries must follow the 10-year rule.  However, distributions from Roth IRA are tax-free 😀
  2. Do you have to “catch up” if you didn’t take distributions in 2021-2024? No, you don’t need to catch up on missed RMDs for these years, in particular.
  3. Do you get an extra year if you don’t take a distribution in 2024? No, the 10-year rule remains in effect regardless of whether you take a distribution in 2024.
  4. Why won’t the IRS waive all RMD requirements? Only Congress has the authority to waive RMDs, not the IRS.

Understanding these rules can help you navigate the complexities of inherited IRAs and make the most of your inheritance. If you’re unsure about your specific situation, consider consulting a financial advisor to guide you through the process.


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Inherited IRAs

Episode 143 •

20th May 2024