When someone inherits an IRA, the tax rules vary greatly depending on who the beneficiary is. In this post, we focus on non-spousal beneficiaries and the “10-year rule” introduced under the SECURE Act. If you are a spouse inheriting an IRA, we covered those rules in our previous blog post, so be sure to check that article as well.
If you inherited an IRA in 2020 or later, these rules apply to you. (For IRA inheritances before 2020, different regulations may still apply.)
What is the 10-Year Rule?
For most non-spousal beneficiaries, inherited IRAs must be fully distributed within 10 years following the year of the account owner’s death. This replaced the old “stretch IRA” strategy, where withdrawals could be spread over the beneficiary’s lifetime.
It’s important to note that the rule doesn’t require annual withdrawals. You may withdraw funds at any time during the 10 years. The account balance is zero by the end of the 10th year. However, taking large withdrawals in a single year may push you into a higher tax bracket.
Required Minimum Distributions (RMDs)
If the original account owner had already begun Required Minimum Distributions (RMDs), the beneficiary must continue taking them each year. This is in addition to following the 10-year rule. At a minimum, the annual RMD must be withdrawn, even if the full account is not yet distributed. (Please refer IRS Publication 590-B for further details)
Also, if the original owner was required to take an RMD in the year of death but had not yet done so, the beneficiary must make that year’s RMD withdrawal.
Exceptions to the 10-Year Rule
The IRS recognizes certain Eligible Designated Beneficiaries (EDBs) who are not subject to the 10-year rule. Instead, they can continue taking distributions based on life expectancy. These include:
– Surviving spouses
– The account owner’s minor children (until age 21)
– Individuals with disabilities
– Chronically ill individuals
– Beneficiaries who are not more than 10 years younger than the decedent
Once a minor child turns 21, the 10-Year Rule begins.
If the beneficiary is not an individual (for example, a trust, estate, or charity), the 5-Year Rule generally applies. In that case, the account must be emptied within five years.
Tax Implications of the 10-Year Rule
Withdrawals from a Traditional Inherited IRA are taxed as ordinary income. They are added to the beneficiary’s taxable income for the year. Since U.S. federal taxes are progressive, this can create a significant impact depending on the timing and size of distributions.
For example:
– John inherits a $400,000 IRA.
– His normal taxable income from salary is $100,000.
– If he withdraws the entire $400,000 in one year, his taxable income becomes $500,000, pushing him into the 35% tax bracket.
– Adding state income tax, John’s tax liabilities would be much higher.
Large withdrawals may also affect Medicare premiums (IRMAA), trigger Net Investment Income Tax (NIIT), or increase the taxable portion of Social Security benefits.
Planning Strategies
Spread withdrawals strategically: Consider taking distributions over multiple years to manage tax brackets.
Roth conversions during lifetime: IRA owners may convert Traditional IRAs to Roth IRAs during their lifetime, making withdrawals tax-free for beneficiaries (though the conversion itself is taxable).
Estate planning: Naming individual beneficiaries (rather than estates or trusts) can prevent triggering the stricter 5-year rule.
Conclusion
Inherited IRA rules—especially the 10-year rule—can significantly impact both taxes and long-term financial planning. Understanding whether you are subject to RMDs, exceptions as an Eligible Designated Beneficiary, or special cases such as trusts and estates is essential. This knowledge helps you avoid costly mistakes.
If you have any questions about how these rules may apply to your situation, please contact us, info@kamitanifs.com, for personalized advice.