Inheriting a retirement account can seem straightforward, but the reality is more complex than it appears. The rules governing Required Minimum Distributions (RMDs) have evolved through multiple legislative updates and IRS regulations. Understanding these rules is crucial to managing your inherited account properly. Here’s a breakdown of what you need to know. In addition, we’ve created two flow charts that visually show the information below.
What is a Required Minimum Distribution?
An RMD is the minimum amount that must be withdrawn from a retirement account each year once the account holder reaches a certain age. For original account owners, RMDs are required starting at age 73, as adjusted by the SECURE 2.0 Act. For beneficiaries, RMDs typically begin in the year following the account holder’s death, though the specifics can vary.
Example: Francis, who is 78, calculates her RMD using the Uniform Lifetime Table. With an IRA balance of $300,000 and a life expectancy factor of 22.0, her RMD for the year is $300,000/22.0 = $13,636.36.
Failing to take the required RMD can result in a penalty. Historically, this penalty was 50% of the missed amount. However, the SECURE 2.0 Act has reduced this to 25%, with the potential to further reduce it to 10% if the mistake is corrected promptly.
Example: Henry missed taking a $10,000 distribution from his IRA. The penalty is initially $2,500, but if he takes the distribution, the penalty drops to $1,000.
Determining RMD schedules for beneficiaries
Beneficiaries of a retirement account must also adhere to RMD rules, but the schedule can vary based on several factors.
Year of death
The year in which the account holder died affects the RMD requirements. Key considerations include:
- Whether the account holder passed away before to the SECURE Act was enacted (pre-2020).
- The applicability of the 10-year rule for beneficiaries.
Required Begin Date
The Required Begin Date (RBD) is the date by which the original account owner must start taking RMDs. This date is April 1 of the year following the account holder’s 73rd birthday (or 75th if born in 1960 or later). If the account holder had reached their RBD before passing, any missed RMDs must be taken by the beneficiaries, who will then determine their own RMD schedule.
Relationship to the decedent
The beneficiary’s relationship to the decedent determines the available distribution options.
- Surviving spouses: A surviving spouse has more freedom for how they treat the account and the distributions, including rolling the account into their own existing IRA or retitling the decedent’s account as their own. Spouses are the only beneficiary that has this option, and it will eliminate any inherited RMDs for the account. Instead, the surviving spouse is treated as the original owner and defaults to taking RMDs when they reach their own RBD.
Surviving spouses may also treat the plan as an inherited account, with options such as the 10-year rule, taking distributions based on their single life table factor, or using the “ghost life expectancy” of the decedent spouse.
Lastly surviving spouses may use the new “Spousal Election” where they treat the defined contribution (DC) plan of the decedent as if they are an employee. This option does not apply to inherited IRAs, is only permitted to sole beneficiary spouses of a DC plan and can be automatic or the default election of the plan. It is important to review the plan’s summary plan description for details on their permitted elections.
- Minor children: Must begin taking distributions according to their single life table factor, reducing that factor by one each year. These distributions will last until the year the child reaches age 31, at which time the entire account must be liquidated. To avoid confusion between states, minors are defined as those under the age of 21 and they must be children (biological, step, adopted, and eligible foster child) of the deceased account holder.
- Special circumstances: For beneficiaries who are either older than or less than 10 years younger than the decedent, or those with disabilities or chronic illnesses, different distribution options apply. They may stretch distributions using their single life table factor reduced by one each year. If the decedent has already started their RMDs and is older than the decedent, they can utilize the ghost life expectancy of the decedent rather than their own shorter life expectancy.
Distribution rules for different types of beneficiaries
All other individuals
For non-spouse beneficiaries, such as adult children or other relatives, the RMD schedule follows the 10-year rule. This rule requires the account to be fully distributed by the end of the 10th year following the account holder’s death. The distribution schedule varies depending on whether the decedent passed away before or after their RBD.
The pre-RBD 10-year rule states that the beneficiary can withdrawal as much or little as they wish during the first nine years following the death, but everything must be liquidated by the end of year 10.
The post-RBD 10-year rule states that if the decedent lived to or past their RBD, the beneficiary must take, at a minimum, distributions for years one through nine and ensure full liquidity of the account by the end of year 10. The stretch distributions are calculated using the beneficiary’s single life table factor reduced by one each year.
Non-Human Beneficiaries
Entities such as charities or estates, which cannot have a life expectancy, are subject to the five-year rule if the decedent died before reaching their RBD. This rule is the same as the pre-RBD 10-year rule but substitutes in five years for 10. If the decedent passes after reaching their RBD, the ghost life expectancy applies where the decedent’s single life factor is utilized and reduced by one each year.
Successor Beneficiaries
What happens if you inherit a retirement account from someone who inherited that same account from someone else? The successor beneficiary rules are easier and based on when the beneficiary died and their RMD schedule.
If the deceased spouse (who was the original surviving spouse) treated the account as their own, either through a direct rollover to their own account or retitling, the “successor” beneficiary is treated as the original beneficiary. If the deceased spouse treated the account as inherited or utilizes the spousal election, the successor beneficiary rules will apply forcing the beneficiary to continue the same RMD schedule as the now deceased spouse was using with full liquidation in 10 years.
If the original beneficiary was stretching the RMDs over their single life table factor without a 10-year timeframe, the successor will continue the same RMD schedule and fully liquidate 10 years after they inherit. If, on the other hand, the original beneficiary was already using the 10-year rule, the successor beneficiary must finish out their 10-year schedule.
Final thoughts
Navigating the rules for inherited retirement accounts can be complex, but understanding the requirements for RMDs can help you manage the account effectively and avoid penalties. If you’re unsure about any specifics, it may be wise to consult with a financial advisor to ensure compliance with current regulations.
