By Sarah Brenner, JD
Director of Retirement Education
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Did you inherit an IRA from someone who is NOT your spouse? This is not uncommon. Maybe you inherited from a sibling or a parent or a friend. If this is your situation, proceed with caution! For non-spouse beneficiaries, a wrong move can result in disastrous consequences. So, take your time and do it right.
Your first step is to contact the IRA custodian to be sure that the account is properly titled as an inherited IRA. Next, carefully explore your options. What are a nonspouse beneficiary’s options when it comes to the inherited IRA?
In the wake of the SECURE Act, most non-spouse beneficiaries can no longer take advantage of the “stretch” IRA. Only eligible designated beneficiaries (EDBs) have this option. Nonspouse EDBs include disabled and chronically ill individuals as well as minor children of the IRA owner and beneficiaries who are not more than 10 years younger than the IRA owner. However, nonspouse beneficiaries who are not EDBs are not forced to take a lump sum distribution. Instead, most nonspouse beneficiaries will be able to spread distributions from an inherited IRA over a 10-year payout period. Annual RMDs may be required during the 10-year payout period if the original IRA owner died on or after their required beginning date. The IRS has waived these payments within the 10-year period for years 2021, 2022, and 2023 due to continued confusion over the rules.
When you inherit an IRA as a non-spouse, you should proceed with extra caution. “Touch nothing!” is good advice. Be aware of all your options and give serious thought to what you want before doing anything. A nonspouse beneficiary who takes a distribution without understanding the tax consequences has no remedy. A nonspouse beneficiary, unlike a spouse beneficiary, does not have the option of rolling over an unwanted distribution. Nonspouse beneficiaries do have the ability to move an inherited IRA to a new custodian, but the move must be done by a direct trustee-to-trustee transfer.
Example: Ben died in 2023 at age 65. He named his two daughters as beneficiaries of his IRA. Daughter Gail consults with a financial advisor and sets up an inherited IRA. She does not take an immediate distribution from this IRA. There is no taxable event. Instead, Gail must empty the inherited IRA account by December 31, 2033. Gail’s advisor sets up a strategy for taking distributions from the inherited IRA over the next ten years, taking into account the rest of Gail’s expected income each year to maximize tax savings.
Daughter Nicole does not consult with an expert and takes a lump sum distribution from her inherited IRA. Nicole will be faced with an immediate large tax bill, reducing her inheritance. There is no remedy for Nicole if she has second thoughts. The distribution cannot be rolled over. Nicole has lost her inherited IRA and gained a tax bill.