RMDs from Inherited IRAs

As you’ve no doubt heard, the Fed finally lowered its short-term benchmark interest rate last week. That’s a sea change in the financial world and should, hopefully, provide a bit of a tailwind for the economy and markets in the near-term. The Fed opted for a 50 basis point (half a percent) reduction.

Fed Chair Jerome Powell indicated further reductions in the coming months without guaranteeing anything. However, markets are pricing in about a 50/50 chance the Fed drops another half percent but by at least a quarter point when they meet again in November. Markets are also expecting reductions totaling around 2% from here, so all this will continue to be top-of-mind for some time to come.

Okay, on to our main topic this morning and continuing our theme from last week.

The deadline for a lot of financial actions each year is December 31^st. We covered “standard” Required Minimum Distributions last week. Now let’s look deeper into the weeds and review considerations when taking RMDs from IRAs you’ve inherited.

RMDs can seem exponentially more complicated when you’ve inherited an IRA. As with last week, I’ll gloss over some of the minutiae to provide a straightforward approach to this topic. As always, consult your humble financial planner or tax professional for specific advice.

The starting age for taking RMDs from your own account is 73 but with inherited IRAs it’s all about how old the decedent was when they passed and how old you are and what your status is when you inherit the account.

Here’s how this process usually begins. The account owner died with you listed as their beneficiary. The custodian of the decedent’s account will want a death certificate and some paperwork completed. You won’t be able to get specific information about the account until the custodian completes their initial processing, but this doesn’t take too long, maybe a couple of weeks if you’re a person versus an entity like a trust or charity.

The custodian will ask if you’d like to open a new account with them or have them send the inherited money elsewhere. Unless you need to spend all of the money now, non-spouse beneficiaries will want to move the money into an Inherited IRA. Assuming so, the custodian will usually take the decedent’s RMD for that year if required and it hasn’t been done already (often splitting this among beneficiaries if there are multiple). Then they’ll transfer the remaining balance into your new account that will be titled something like, “Jane Doe Inherited IRA, Beneficiary of Sally Johnson”. You can often elect to receive the investments already in the account, or you can have everything sold and receive cash into your new account – either way the transfer itself isn’t taxable.

This sets your new account apart from your other IRAs, Roth IRAs, 401(k) plans, etc, and is where the complexity begins.

If you’re the surviving spouse, it’s generally best to skip the Inherited IRA and put this money into your own IRA, assuming you have one. This let’s you treat the inherited money as your own for RMD purposes and generally makes the process simpler.

Pretty much everyone else will need to contend with a variety of issues.

If the decedent died this calendar year, the government lets you wait until next year to start taking money out. You can withdraw immediately, but you won’t be required to start taking your own RMDs until the following year. The deadline is December 31^st each year.

Distributions from a Traditional, Rollover, or Contributory IRA (different names for essentially the same account) are taxed as ordinary income, so yours will be too. Distributions from a Roth IRA likely won’t be taxed but still follow the same general RMD rules. There are penalties for missing an RMD, so you’ll want to understand how they work and not forget about them.

Look up the “Single Life Table” via a Google Search, or you can use this one: https://www.fidelity.com/building-savings/learn-about-iras/irs-single-life-expectancy-table

Find your age during the year the account owner died and divide the balance (a specific number provided by the custodian) by that year’s life expectancy factor. That’s your RMD. In subsequent years you’ll subtract 1 from the starting-year factor and redo the math with the then-prior year’s ending balance.

However, the government mandates that most non-spouse beneficiaries completely drain the account by the end of ten years starting the year after death. That used to be a five-year window and you had the ability to “stretch” an IRA over a beneficiary’s lifetime. No longer in most situations.

So does that mean you should skip the Single Life Table and divide the balance by ten? Or should you just take the minimum each year and draw the remainder in year ten? Or some other variation?

For some the answer is simple. They’ll take all the money quickly because they’re going to spend it. But others might prefer to let the money grow.

Essentially, it’s all about taxes and when you pay them.

There are specific rules depending on if the decedent was taking RMDs, but I suggest for most non-spouse beneficiaries its simplest to divide by ten to smooth out the tax burden over the full distribution period. But you can opt to take the minimum each year while opportunistically taking more in other years as your tax situation allows. Careful planning is critical to manage taxes but also to ensure the account is emptied on time.

As I mentioned above, this is meant to be helpful summary and shouldn’t be considered specific advice. Part of this is due to the rules being different for:

A spouse more than ten years different in age from the decedent.

Beneficiaries who are minors when they inherit.

Beneficiaries who are chronically ill when they inherit.

Beneficiaries who inherit from other beneficiaries.

Certain types of trusts that inherit a retirement account.

Or inheriting an account from an employer plan versus an IRA or Roth IRA.

Of course we’ll help you with this stuff if you’re a client, but here’s a more detailed article for the DIY types out there. This content is meant for planners so it’s a little dense and long. However, there are some good flow charts to help determine what options are available to different types of beneficiaries.

https://www.kitces.com/blog/secure-act-2-0-irs-regulations-rmd

Isn’t our tax code wonderful!

Have questions? Ask us. We can help.