When someone with an IRA dies, the investment company that holds the IRA will review the beneficiary form to determine who is entitled to the money in the account.

While the rules for those inheriting a deceased spouse’s IRA have not changed, The Secure Act of 2017 changed the rules for non-spouses inheriting IRAs in the year 2020 or later. Here is what you need to know.

NEW: If an IRA Owner Dies on 1/1/2020 or Later

• A non-spouse beneficiary should transfer the decedent’s IRA to a new “Inherited IRA” or “Inherited Roth IRA” in their own name.

  • For example, if one of my parents dies and leaves me an IRA, then I would open up an Inherited IRA FBO (for the benefit of) Linda Rogers at the custodian of my choosing. I would then do a trustee-to-trustee transfer to move the money from the current IRA to the new Inherited IRA, avoiding any tax consequences. Similarly, if my parent leaves me a Roth IRA, I would set up an Inherited Roth IRA.

  • The IRS requests that the new Inherited IRA indicates the original owner and the beneficiary. Most investment firms will title the account something like this: John Smith, IRA (deceased on 1/5/2021) FBO Linda Rogers, beneficiary.

Required Distributions from Inherited IRAs

• If the beneficiary is a non-spouse and is not eligible for an exception (see below), here are the new rules that they need to follow. (This is what changed with The Secure Act of 2017.)

• The money in the newly established “Inherited IRA” or “Inherited Roth IRA” needs to be distributed within 10 years after the death of the original account owner.

• The 10-year mark starts the year after death and ends 10 years later on December 31st. For example, if someone dies in 2020, then Year 1 is 2021 and the new Inherited IRA or Inherited Roth IRA account needs to be emptied by 12/31/2030.

• Clarification from recent IRS guidance - While everyone read the new law as saying beneficiaries could distribute as much as they wanted, or none at all, as long as the account was emptied by year 10, the IRS contradicted that in recent guidance. If the original owner was subject to RMDs at their death, the beneficiary needs to continue taking RMDs. These new rules will become effective in 2024 according to another round of guidance.

• Inherited IRA distributions will not be subject to a penalty for those that are under the age of 59 1/2, but beneficiaries will pay ordinary income tax rates on the Inherited IRA distributions. Distributions from Inherited Roth IRAs are tax-free.

• Exceptions: If the beneficiary of the IRA falls into one of the exception categories listed below, they have the option to take required minimum distributions (RMDs) based on their life expectancy.

• Surviving spouse

• Minor child

• Disabled

• Chronically ill

• Anyone less than 10 years younger than the deceased account holder (such as a sibling)

Financial Planning Strategies to Consider Given the Law Change

If you are a non-spouse beneficiary that does not qualify for one of the listed exceptions (disabled, chronically ill, etc), and the original owner was not subject to RMDs at their death, you are not required to take any distributions from the Inherited IRA or Inherited Roth IRA within the 10-year period. You can distribute everything at once, everything in Year 10, or spread out the payments evenly over the 10 years. Given this flexibility, it may make sense to leave all of the money in the Inherited Roth IRAs for as long as possible. Doing so will maximize the tax-free growth in the account and a full distribution can be made in Year 10 with no tax consequences.

For Inherited IRAs, the decision is more complicated. Do a tax projection to understand how your marginal tax bracket will be affected by different distribution strategies. It may make sense with Inherited IRAs to distribute 1/10th of the account every year to avoid a big tax bill that may come with distributing everything all at once. Or, perhaps you plan on retiring in 5 years and will wait and take distributions at that time when you expect to be in a lower tax bracket.

If you Inherit an IRA, work with a Financial and Tax Professional.

Work with someone that is staying on top of law changes and who understands the financial and tax consequences of different strategies. Subscribe to PWR’s newsletter below for more financial and tax tips.

Updated 1/17/2023 to reflect recent IRS guidance.

Linda Rogers, CFP®, EA, MSBA is the owner and founder of Planning Within Reach, LLC (PWR). Originally from New Jersey, Linda services clients throughout San Diego county and nationwide. She leads the design of PWR's investment portfolios which utilize broad, low-cost investments that integrate environmentally, socially, and governance (ESG) factors.

Planning Within Reach, LLC (PWR) is a fee-only and fiduciary wealth management firm offering one-time comprehensive financial planning, ongoing impact-focused investment management and tax preparation services in San Diego and nationwide. PWR is a woman-owned firm that specializes in busy professionals and impact investors. Planning Within Reach, LLC and their advisors do not receive commissions and do not hold any insurance licenses or brokerage relationships.