Inherited IRA Distributions: Post SECURE Act [Video]by Michelle Smalenberger, CFP® / April 26, 2023
Today’s topic might leave you feeling a little overwhelmed. There is a lot of information about inherited IRA distributions.
Hi, I’m Michelle Smalenberger, a CEO and financial advisor here at a Financial Design Studio. Today we are talking about inheriting an IRA post SECURE Act. Honesty we are seeing a lot more inherited IRAs because with our aging population, more of these accounts are being handed down to beneficiaries, like you.
About Inherited IRA Distributions
The goal of today’s video is that I want to help explain and make sense of a lot of the rules. We are going to talk about what you have to do, but ultimately we are going to talk about what you can do with these accounts. I’m going to point you to other resources along the way too!
So first off, there is some information that you will need to know. These are really simple pieces of information that will affect how you have to take money out of these accounts and by when.
How old were they when they passed away? When was their birthdate? Did they pass away before or after Jan 1, 2020? Have they started taking their Required Minimum Distributions (RMDs)? Some of this we can calculate but just knowing is helpful for you
How does the SECURE Act Affect Beneficiaries?
As we find this information, we are going to start to dig into the different types of beneficiaries so you can see who you are. Now, the SECURE Act was a piece of legislation that defined how people can inherit retirement accounts from loved ones. You can read more about the SECURE Act in our article here!
If your loved one passed away after the SECURE act, after January 1, 2020, these are now the rules that impact you.
So, if this is you, then let’s ask this question: who is the beneficiary? Who are you from this list? I’m going to talk you through the three types of beneficiaries, then we will talk about how this impacts what you have to do.
Eligible Designated Beneficiary
Let’s talk about the Eligible Designated Beneficiary (EDB). The SECURE Act defines this beneficiary as someone who: is the spouse, a minor child of the deceased person, an individual who is less than ten years younger (think of someone like a sibling), or an individual who is chronically ill or disabled. If you fit any of these and you were listed as a beneficiary directly, then you are an EDB.
So the next group of beneficiary is a designated beneficiary. This simply means that you are listed as the beneficiary but you do not have the qualifying EDB characteristics, like being the spouse or minor child. You might be a friend or a member of the extended family.
Non Designated Beneficiary
Now, maybe you are someone who is a non designated beneficiary. This simply means that your name was not listed directly on the account, however, you are the beneficiary because the Will or the Trust or the Estate plan listed you. So, a non designated beneficiary was not listed on the direct accounts.
It depends on what type of beneficiary you are for how you have to take money out of these accounts. I said how you HAVE to take money out of these accounts. That’s what becomes really important and you will see how planning is crucial to create options for you.
Eligible Designated Beneficiary Distributions
If you were an Eligible Designated Beneficiary, you are one of those five people, then you can stretch distributions out over your lifetime. You may have to take a little bit out each year, depending on who you are.
One note on this, if you are a minor child, you can only stretch the distribution out until you are the age of majority, or around age 21. You should check your state just to be sure. After that age, you are no longer a minor child and now the Ten Year Rule applies to you.
The Ten Year Rule says that within ten years of inheriting the account, or after you turn the legal age of majority, you have to take all the money out of the account within ten years. You could take a little out each year, you could take it out all at once, but you have to take it out within ten years. That is the Eligible Designated Beneficiary.
Required Minimum Distributions
Remember the information I said you would need? Here’s when you need it. How you take out your inherited IRA distributions depends on whether Required Minimum Distributions (RMDs) have started yet.
As people are aging and maybe retiring, the Required Beginning Date is when people have to start taking money out of their accounts (RMDs). But the actual date depends on what type of account you own. That’s why this Required Beginning Date is important to know. We’ve already done videos on the Required Beginning Date for RMDs. If you are looking to better understand this topic, check out this video!
Don’t feel like you have to know all these things, we can look back at their birth date and calculate the proper dates of what they qualify for and when.
Designated Beneficiary Distribution
Let’s go back to what you have to do as a designated beneficiary. If your loved one passed away before their Required Beginning Date, then you are under the Ten Year Rule and have to take all the money out within ten years.
Now if your loved one passed away after their required minimum date and they had already been taking money out of their retirement date, then you are still under the Ten Year Rule, but you also have to take Stretch Distributions.
This means not only do you have ten years to take all the money out, but if you are going to wait until year ten, you have to be sure to take a little bit out of the account each year. You have to stretch it out over those ten years.
Why Planning Matters
This is where you need to be planning, because if you decide to wait until the tenth year, and you didn’t take the minimum amount out, you will need to pay a penalty. This is what makes planning so complex.
What is really cool is when you are planning and when you start talking about what you want to use this money for and when you need it, that’s when you can start to create a plan to figure out the best way for you to take it out. That’s why it’s important to understand what you have to do, then you can figure out what you can do.
Non-Designated Beneficiary Distributions
Alright, let’s talk about this last type of beneficiary: the non-designated beneficiary. This is someone who is not listed on the account, but it listed on the Will, Trust, or Estate plan.
If this is you and your loved one passed away before their Required Beginning Date, then you have the Five Year Rule, meaning you have to take money out of this account within five years. This is really important for you to know as this is a short window of time.
Now if your loved one had passed away after their Required Beginning Date and they had already started taking money out of their account, then you have the Five Year Rule, but you also have the Stretch Distribution. This means you need to take money out each year.
If you don’t there are penalties you have to pay. This is why we think estate planning is the perfect mix of tax planning, investing, and financial planning, so we can make sure you keep as much as possible.
What Type of Account is the IRA?
Let’s talk about the last piece that is important. This is the type of account you inherited. You can look on the statement to see. It might be a traditional IRA, a Roth IRA, a SEP or a Simple or more employer sponsored accounts, or a 401K or a 403B.
Each of these accounts have different tax implications. That’s why you need to know. Even with a Roth IRA or a Roth 401K, there may be no taxes you have to pay when taking the money out but you need to figure out when you should take money out.
Next Steps for Inherited IRA Distributions
There are a lot of strategies you can consider to keep even more. That’s why the timing matters. You could be getting these inherited IRA distributions from these accounts in your highest income earner years, pushing you into the highest tax brackets. These distributions will add onto that tax burden. So this is where financial planning is the perfect intersection of tax planning, investing, and cash flow.
If this is something you are thinking, “I need help but I want to make sure that the person who is going to help knows and understands this information,” I want to send you to our website where you can check out our tax planning, financial planning, and estate planning pages.
I hope this has been helpful. But, if you find yourself saying, “wait I think I might be a pre-secure act beneficiary to an inherited IRA,” we have another video coming out next to help you understand what you’ve got. Subscribe to our YouTube channel to make sure you don’t miss it!
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