Inheriting substantial assets from a parent is becoming quite common, especially if you are a part of the Baby Boomer generation. This is largely due to the tremendous savings habits of the generations that came before, and that is why we’ve created this guide to inheriting an IRA from a parent.
While it may provide you with a nice windfall, often times an inheritance can get quite complicated, particularly when inheriting an IRA from a parent after January 1st, 2020.
The recently passed SECURE Act that went into effect January 1st, 2020 made significant changes to rules for retirement accounts, more specifically for beneficiaries of these accounts.
Even more recently, SECURE Act 2.0 went into effect January 1st, 2023 and added nearly 100 retirement legislation changes! However, there were no changes directly relating to IRAs inherited by non-spouse beneficiaries.
For the most part, the rules from the original SECURE Act in 2020 are more restrictive than decades prior and therefore require increased attention to planning for certain beneficiaries.
This is a comprehensive guide.
We highly suggest that you use the Table of Contents to navigate to relevant topics.
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New Changes for Beneficiaries Inheriting an IRA
Here are some key highlights as they relate to certain beneficiaries who inherit an IRA after January 1st, 2020 (original IRA owner died after 1/1/2020), due to the SECURE Act:
- The “stretch IRA” is no longer available for most non-spouse beneficiaries.
“Stretch IRAs” are essentially IRAs inherited pre-2020 that allow a beneficiary to “stretch out” the required minimum distributions (RMD) they must take each year (per the IRS) over the beneficiary’s own life expectancy.
The term “stretch IRA” is a provision that almost all IRAs have. It is not an actual type of IRA that you go and open.
The stretch is still available to a spouse named as the beneficiary of an IRA inherited after 2020, and certain other non-spouse beneficiaries which we discuss later.
The stretch is still available if you inherited an IRA from a parent before 2020.
The beneficiary must be specifically named on the IRA being inherited in order to utilize the stretch. This is called a “designated beneficiary”.
- There are new “categories” of beneficiaries that determine your required minimum distribution (RMD) options as a beneficiary starting in 2020.
- Most non-spouse beneficiaries such as those inheriting an IRA from a parent will be subject to a new “10-year rule” for taking their RMD. This is opposed to stretching the RMDs over their life expectancy.
- These rules apply to traditional inherited IRAs as well as inherited Roth IRAs!
- If a trust has been named as the beneficiary of an IRA, things can get quite complicated – more on this later.
- SECURE Act 2.0 changes to penalty for missed RMD:
Post-SECURE Act 2.0 and effective beginning in 2023, the penalty for not taking your RMD is 25% (was 50%), and the penalty is further reduced to 10% if fixed during the “Correction Window”.
The Correction Window begins on the date the tax is imposed, and ends at the earliest of:
1. When the “Notice of Deficiency” is mailed to the taxpayer;
2. When the tax is assessed by the IRS; or
3. The last day of the second tax year after the tax is imposed.
Categories of IRA Beneficiaries
Calculating your required minimum distribution (RMD) and when to take it depend on the category of beneficiary you fall into when inheriting an IRA, particularly from a parent as of January 1st, 2020.
Determining the type of beneficiary you are should be the first step taken when inheriting an IRA.
Eligible Designated Beneficiaries (EDB): This category of beneficiaries can still utilize the stretch IRA provision for their RMDs. As the name suggests, they must be actually designated as a beneficiary on the IRA. They include:
- Minor children (but not grandchildren)
- Those with qualifying disabilities (per IRS rules) or chronic illnesses
- Individuals who are not more than 10 years younger than the IRA owner
Eligible Designated Beneficiaries are provided with the most flexibility when it comes to income and tax planning under the new legislation.
A spouse beneficiary who is the sole inheritor (which is an EDB) can refer back to the SINGLE LIFE EXPECTANCY TABLE each year to re-calculate their life expectancy based on their age each given year.
You will notice that the table shows a slightly longer life expectancy when done this way compared to the method used by non-spouse EDBs. This is a good thing because it will result in a lower RMD that must be taken, which offers more flexibility.
A spouse can also decide to do a spousal rollover to their own IRA, rather than leave it as an “inherited IRA”. Speak to a professional to see if this makes sense for you.
Noneligible Designated Beneficiaries (NEDB): This category of beneficiaries cannot utilize stretch IRA provisions and are subject to a new “10-year” rule for their RMD.
Again as the name suggests, they must be actually designated as a beneficiary on the IRA.
Nearly all adult children inheriting an IRA from their parents will fall into this category.
- Adult children
- Some qualifying trusts that have been named (designated) as a beneficiary of an IRA
Most non-spouse beneficiaries fall into this category. Unfortunately, NEDBs will not have the same flexibility as those non-spouse beneficiaries who inherited an IRA from a parent before 2020 due to the new 10-year rule.
Non-Designated Beneficiaries (NDB): This is typically the least desired category of beneficiaries. These beneficiaries have no life expectancy and therefore cannot utilize the stretch provisions for their RMDs.
Instead, the RMD rules for these beneficiaries depend on when the account owner dies. They include:
- Estates – This happens when there is no beneficiary named.
- Non-qualifying trusts (typically non “see-through” trusts, or those without real human beings as the beneficiaries of the trust)
If you inherit an IRA through an estate, or a trust that doesn’t qualify, you are a non-designated beneficiary. This is the least desirable treatment due to the lack of income and tax planning flexibility.
To add insult to injury, the process of getting the inherited funds to the beneficiaries in these situations can actually cost money and take years!
Making sure you don’t become a non-designated beneficiary is actually an incredibly easy fix, you just need to make sure it is done before the IRA owner passes.
Simply name a beneficiary! Preferably a living, breathing human being. Help your parents review their beneficiaries regularly to make sure their assets pass the way they intended.
Naming an IRA beneficiary in a will, and not on the IRA itself is a huge mistake! This will (pun intended) cause the IRA to pass through the estate, meaning that the beneficiary is still not designated!
See, planning pays off!
Determining Your RMD When Inheriting an IRA
Now that you know how to determine the category of beneficiary you fall into, you can begin the next step in figuring out what your RMD(s) will be.
More importantly, you can begin to piece together the different financial and income tax planning options you’ll have.
RMD for Eligible Designated Beneficiaries (EDB):
This is not applicable to most adult children inheriting an IRA from a parent.
This is however crucial to understand if you meet some of the other unique qualifications for an EDB discussed prior.
- For EDBs utilizing the stretch, the first RMD should be taken from the inherited IRA by December 31st of the year following the original account owner’s death.
- For purposes of calculating the first RMD for the inherited IRA, an EDB should find their life expectancy (per the IRS) using the SINGLE LIFE EXPECTANCY TABLE*.
*See pg. 2 of Planable Wealth’s “2023 Important Numbers” to see an abbreviated version of the table
- Take the life expectancy factor and simply divide it into the inherited IRA’s ending account balance as of December 31st of the prior year. The resulting number is the RMD amount that must be taken out and taxable to the beneficiary by December 31st.
- When calculating RMDs for subsequent years, a non-spouse EDB will use their original life expectancy number determined by the table and reduce it by 1 each year thereafter.
There is no need to refer back to the table again.
Each year you continue to subtract 1 and the resulting number is then used as your “life expectancy factor” in the calculation for that year’s RMD.
Diana age 89, passed away in June of 2021 and her chronically ill 62-year-old daughter Gabby inherits her IRA that had a value of $100,000 as of December 31st, 2021.
Gabby must take her first RMD by 12/31/2022 since she is an EDB eligible to stretch due to her chronic illness.
To calculate her first RMD, Gabby will refer to the Single Life Expectancy Table and see that her life expectancy factor is 23.5.
$100,000 / 23.5 = $4,255.32
Her RMD is $4,255.32 for 2022. If she does not take that amount out of the IRA by year end, she will owe a penalty of $2,127.66 (50%) along with any applicable income taxes.
In 2023 Gabby will simply subtract 1 from 23.5 to get 22.5 as her new life expectancy factor and divide that into the ending account balance of the inherited IRA as of December 31st, 2022. The following year would be 21.5 and so on.
- If the EDB is a minor child who utilizes the stretch provision, they will have to revert to the 10-year rule once they reach the age of majority which is determined by state law.
RMD for Non-Eligible Designated Beneficiaries (NEDB):
This applies to nearly all adult children inheriting a parent’s IRA as long as they are individually named as beneficiaries on the IRA itself.
This category of beneficiaries use the new 10-year rule established by the SECURE Act.
Although not yet a final regulation, during 2022 the IRS gave “proposed regulations” on how they would like the 10-year rule applied via Notice 2022-53 (over 2 years after the 10-year rule was established).
If a beneficiary falls under the 10-year rule as a non-eligible designated beneficiary, the rules are as follows:
- The original account owner dies before their Required Beginning Date (RBD) – April 1st of the year following the year they reach age their RMD age – then there is no change and there is still ONE RMD equal to 100% of the account balance that needs to be withdrawn by 12/31 of the 10th anniversary year of death (i.e. owner dies Feb 2021, RMD must be taken by 12/31/2031).
- The original account owner dies after their Required Beginning Date (RBD) – April 1st of the year following the year they reach their RMD age – then the beneficiary must take annual RMDs in years 1-9 based on THEIR OWN life expectancy using the Single-Life Expectancy Table AND the account(s) must be depleted by the end of year 10.
- Note that the first annual inherited IRA RMD isn’t actually required to be taken until 12/31 of the year following the year of death. Therefore, if an original owner died in 2022, the beneficiary wouldn’t need to take the first RMD until sometime in 2023.*
*Don’t be confused by the beneficiary’s RMD vs. the original account owner’s RMD. Remember that if the original account owner was already passed their RBD and taking their own RMD before they passed, but had not yet taken it in the year of death, the beneficiary(ies) must take it on their behalf by 12/31 in the year of death!
- Inherited Roth IRAs – The Required Beginning Date (RBD) does not matter! There is only ONE RMD of 100% of the account balance that needs to be withdrawn by 12/31 of the 10th anniversary year of death (i.e. owner dies Feb 2022, RMD must be taken by 12/31/2032).
- Although you wouldn’t owe income taxes, if you don’t drain the account by the end of year 10, you would owe a potential 25% or 10% penalty on your otherwise tax-free money!
As long as the original account owner did not pass after their RBD, you still have full flexibility within the 10-year time frame of how to distribute money from the account.
Example: If your parent passes away in 2022 and you are their sole designated beneficiary as an adult child, you will have until December 31st of 2032 to withdrawal the entire account balance however and whenever you want to do it.
Depending on your tax situation you may want to take more from the account in years where your income is low. There are numerous ways to strategize in order to take advantage of this.
Consider talking to a professional to implement a strategy that will potentially reduce the taxes owed on your inherited retirement accounts.
There can be years where you make no withdrawals, or years where you may decide to withdrawal 1/3 of the balance for example.
You can even attempt to take equal amounts over the 10 years as long as the account is empty at the end of year 10!
Bonus Planning Tip:
If the funds in the account are invested, they will have various rates of return every year. Therefore if you want to try and take the money as evenly as possible over the 10 year period, you can determine an expected average rate of return for the account and run an amortization table!
This is similar to how your mortgage payment is determined with the interest included.
In this case the “loan” balance is your account balance, your time period is 10 years, and the interest rate % for the mortgage is just your expected average return % instead! This can give you a good estimate for level payments!
RMD for Non-Designated Beneficiaries (NDB):
The RMD rules for NDBs depend on when the original account owner dies. Specifically, whether they pass before or after their “Required Beginning Date” or “RBD”.
As previously mentioned, either outcome almost always leaves this type of beneficiary with the least amount of flexibility, especially when it comes to taxation.
- The Required Beginning Date (RBD) is April 1st of the year following the year an account owner turns 72. This is the date in which an original IRA account owner must begin taking their RMDs.
- If the IRA account owner dies BEFORE their RBD, then the non-designated beneficiary must take 100% of the inherited IRA account balance by the end of the 5th year following the account owner’s death.
This withdrawal rules are similar to the 10-year rule we discussed in which the beneficiary can withdrawal in whatever manner they please as long as the account is empty by the end of year 5.
- If the IRA owner passes AFTER their RBD, there will be an annual RMD calculated based on the IRA owner’s remaining life expectancy (had he/she lived), using the SINGLE LIFE EXPECTANCY TABLE.
When referring to the table, you would use the age of the IRA owner when he or she passed to find their remaining life expectancy.
To determine the RMD for subsequent year, you will subtract 1 from the original life expectancy determined by the table to get the current year’s new “life expectancy factor” for your calculation.
- The first RMD in this case needs to be taken by December 31st of the year following the account owner’s death.
Patrick dies in 2021 at age 79 and listed a beneficiary in his will, but not on his IRA. The beneficiary that ultimately inherits the IRA must take their first RMD by December 31st of 2022.
After referring to the Single Life Expectancy Table, the beneficiary finds the remaining life expectancy for a 79-year-old to be 10.8.
However, because the first RMD wasn’t “due” until one year later in 2022, the life expectancy factor must be reduced by 1 to get 9.8.
The factor of 9.8 will be divided into the inherited IRA ending account balance as of December 31st of 2021 to determine the first RMD.
- If the IRA owner had not yet taken their own RMD in the year they passed, the beneficiary must take that RMD on their behalf by December 31st of the year in which the IRA owner passed.
A common situation arises when an IRA account owner who had not yet taken their own RMD dies shortly before year-end, and therefore the beneficiary doesn’t have enough time to take the owner’s RMD.
In this case the beneficiary should take the year of death RMD as soon as they can in the following year and file a form 5329 with their own tax return to ask for a penalty waiver.1
The distribution should go to and be taxable to the beneficiary (not the estate of the original account owner).
The beneficiary should also send a copy of an account statement to the IRS showing the distribution of the RMD amount. In these cases, the probability is high that the IRS will waive any potential penalties.
SECURE Act 2.0 Changes to Required Minimum Distribution Age Affects Required Beginning Date
Beginning in 2023, the required minimum distribution (RMD) age is pushed to age 73 for those turning 73 between 2023 and 2032.
The RMD starting age is pushed back to age 75 for those turning 73 in 2033 and future years*
|Birth Year||Changes from SECURE Act. 2.0|
|1951-1959*||RMD age pushed to 73|
|1960||RMD age pushed to 75|
*There is currently an error in the law that reflects those born in 1959 having an RMD age of 73 and 75. This assumes it is eventually corrected as intended by Congress to age 73.
Prior to the SECURE Act 2.0, from 1/1/2020 to 12/31/2022, the RMD age was 72.
If a parent turned 72 in 2021, their required beginning date would have been April 1st, 2022. If the parent then passed away later in 2022 with a traditional IRA, an NEDB beneficiary would use 4/1/2022 as the RBD to determine their own RMD requirement.
The beneficiary would therefore have inherited IRA RMDs in years 1-9 + one final RMD of 100% of the remaining account balance by 12/31/2032.
Trust as Beneficiary of a Parent’s IRA
For those that have – or are children of those that have – a trust designated as the beneficiary of an IRA, the SECURE Act may have upended your estate plan.
Since the SECURE Act came into effect in 2020, there have already been countless situations that are leaving beneficiaries very upset.
While inheriting an IRA from a parent may be a kind gesture, inheriting through a trust might be one last pinch from Mom and Dad.
If you are a party to this situation, you will want to understand the potential ramifications so that wishes are carried out as intended when the trust creator (grantor) passes.
Most people do not need to name a trust as a beneficiary and can often accomplish the same goals by naming individuals as beneficiaries of the IRA instead.
Often times we will see trusts named as IRA beneficiaries out of laziness because it requires less “work” at the time of account opening (i.e. gathering all names, dates of birth, addresses, socials, etc.). Don’t be lazy!
However, this is not always the case. Sometimes there are legitimate reasons to name a trust as a beneficiary. Some examples could be:
- You have one or more special needs beneficiary(ies)
- You want to restrict access to the funds until the beneficiary(ies) reaches a certain age
- Second marriages – You want to support spouse but leave potential remaining money to your own kids, not theirs.
- Mentally incompetent beneficiary(ies)
- Beneficiary(ies) have significant creditor problems and risks
- Beneficiary(ies) known to have bad spending habits
If you absolutely must name a trust as a beneficiary, make sure it qualifies as a “see-through trust”.
Why? Because as you may recall from the prior sections, most qualifying see-through trust beneficiaries get to utilize the 10-year rule for RMD purposes.
To qualify as a see-through trust (also commonly referred to as a “look-through trust”), it must meet the following parameters:
- The trust must become irrevocable upon the death, and valid under state law
- There must be identifiable individuals named as beneficiaries of the trust itself
As a beneficiary of a see-through trust, make sure to provide the investment provider (custodian) of the IRA with a copy of the valid trust documents before October 31st of the year following the year of the IRA owner’s death.
If the trust qualifies, this may allow the trust beneficiaries to be classified as “designated” beneficiaries.
From there, each beneficiary can either be an eligible (EDB), or non-eligible (NEDB) beneficiary depending on their individual circumstances (see section “Categories of IRA Beneficiaries”).
This means that any potential EDBs who are trust beneficiaries will actually be able to still stretch their RMD over their own life expectancy, while others may be NEDBs subject to the 10-year rule!
Ah, it all makes sense now!
If the trust is not qualified, the IRA will have to be distributed sooner than 10 years, not allowing much flexibility when it comes to tax planning!
In this case the trust is deemed to not have any designated beneficiaries and therefore the ultimate beneficiaries will become non-designated beneficiaries (see section “Categories of IRA Beneficiaries”).
These beneficiaries will be subject to the less-than-ideal RMD requirements for NDBs. This can easily leave beneficiaries with less money than intended!
Even though a qualifying see-through trust offers far more flexibility than a trust that doesn’t qualify, there can still be major issues that surface.
Let’s look at an example:
Mary passes away and has her qualifying see-through trust as the beneficiary of her IRA because she has two adult children that will surely blow the money the moment it gets into their hot little hands.
Therefore, she has specific language in her trust which says that the beneficiaries can only access a very limited amount of the inheritance each year. This was done ultimately for her kids’ protection and wellbeing.
The beneficiaries are considered NEDBs in this case, meaning that they are subject to the 10-year rule due for their RMD. However, the new inherited IRA is in the trust and money can only be paid out of the trust to the beneficiary per the trust’s terms.
When the RMD subject to the 10-year rule is paid out, it will first be distributed to the trust from the IRA, then subsequently paid out to the beneficiaries from the trust (2 steps).
Herein lies the problem…
If they aim to take the RMDs in equal amounts annually over the 10 years to provide supplemental income, they may be limited to only a portion of that annual RMD if the amount Mary allowed for to be paid annually from the trust is less than the RMD amount.
This can leave some of that RMD money left over in the trust each year which would then be taxed to the trust (and not the beneficiaries) at MUCH higher trust tax rates! These rates can quickly reach nearly 40%!
Let’s say that they wait and take the 100% RMD in year 10 in order to try and avoid this issue. That means that the RMD will be distributed to the trust, then hopefully sent to the beneficiaries, and they will be responsible for paying the income tax on the entire account balance in one year!
This can put them into higher tax brackets and cause all sorts of issues, let alone cause them to pay more than they need to in taxes.
Even though you may intend to protect your beneficiaries’ financial wellbeing, the resulting possibilities of tax consequences can cause the same amount of damage. However, in that case the money goes to the IRS and not your beneficiaries! Talk about a nightmare!
Additional Tips Regarding IRAs and Trusts
- There are no additional tax benefits to naming a trust as a beneficiary of an IRA vs. an individual.
- Trusts have separate income tax tables than individuals do. The 37% tax rate kicks in at just $13,050 in taxable income for 2021.
- Money left undistributed from an irrevocable trust each year is taxed to the trust. Money that is distributed out of an irrevocable trust to the beneficiaries in a given year is taxed to the beneficiaries.
- There are such things as “IRA trusts” that are created specifically for those who have special circumstances and need a trust as the beneficiary. Please note that creating these types of trusts with an estate planning attorney these can get fairly costly.
- If an IRA remains in an irrevocable trust after the owner’s death, a trust tax return will need to be filed every year going forward and this can cost a lot of money over time!
- If you inherit an IRA from a parent who is already following the 10-year rule themselves as a beneficiary (twice inherited), then you must continue their same 10-year payout where they left off.
- You can have multiple IRAs with different beneficiaries of each IRA. This concept can be used as a very strategic tool in your estate planning.
The Bottom Line
Inheriting an IRA from a parent can be straight forward or introduce more complexities than your high school statistics book if there is a lack of proper planning.
Having the knowledge to help your parents with their finances while they are alive and competent could help save you thousands as a beneficiary.
You will be able to make sure your own estate plans are bullet proof by making sure that aunt Iris (the IRS) doesn’t become an unintended beneficiary of your hard-earned money as well!
A good practice is to review your beneficiaries and estate plans annually. Life brings many changes and we tend to forget the little things, after all we’re only human.
For more creative planning and investment insights, check out our podcast: Retired·ish.
Cameron Valadez is a CERTIFIED FINANCIAL PLANNER™ located in Riverside and Orange County, CA.
Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, and CFP® in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.
1 Slott, Ed. “Appendix: Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts.” The New Retirement Savings Time Bomb How to Take Financial Control, Avoid Unnecessary Taxes, and Combat the Latest Threats to Your Retirement Savings, Thorndike Press Large Print Nonfiction, Waterville, 2021, pp. 390–390.