In episode 18 of the “Financial Focus” video series, JGUA President & Chief Operating Officer, Jason Nickerson, CFP®, EA, dives into the recent guidance from the IRS on inherited IRA’s and why that guidance remains confusing…

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IRS Guidance on Inherited IRAs & Why I Am Still Confused By It!

Inherited IRAs have long been a subject of confusion and frustration for many taxpayers. As individuals navigate the process of inheriting an IRA, the Internal Revenue Service (IRS) has provided guidance to help clarify the rules and regulations surrounding these accounts. Unfortunately, even with this guidance, many individuals, myself included, still find themselves scratching their heads.

Firstly, it is important to understand the basics of an inherited IRA. When an IRA owner passes away, the account can be inherited by a spouse, a non-spouse beneficiary, or a trust. The IRS has specific rules depending on the relationship to the deceased IRA owner.

For spouses inheriting an IRA, they have the option to treat it as their own by rolling it into their existing IRA or creating a new one. This allows the spouse to delay required minimum distributions (RMDs) until they reach the age of 72. However, if the spouse is younger than the deceased owner, they may face limitations on contributions and early withdrawal penalties.

Now, when it comes to non-spouse beneficiaries, things get a bit trickier. Non-spouse beneficiaries cannot treat the inherited IRA as their own. Instead, they must start taking RMDs based on their own life expectancy by December 31 of the year following the owner’s death. Failure to take RMDs in a timely manner can result in hefty penalties.

Here is where the confusion sets in – the IRS has different rules for non-spouse beneficiaries who inherit an IRA before or after the owner’s required beginning date (RBD). The RBD is usually April 1 following the year the owner turns 70 and a half years old (or the year of their death for IRAs not subject to RBD). If a non-spouse beneficiary inherits before the owner’s RBD, they have the option to take distributions over their own life expectancy or distribute the entire inherited IRA balance within 10 years.

However, if the owner passed away after their RBD, the non-spouse beneficiary must take distributions based on the owner’s remaining distribution period. The distribution period is determined by the beneficiary’s age in the year following the owner’s death. Confusing, right?

To add even more complexity, the SECURE Act, passed in 2019, made significant changes to the rules surrounding inherited IRAs. It eliminated the “stretch” provision for most non-spouse beneficiaries, meaning that they now generally must distribute the entire inherited IRA within 10 years, regardless of whether the owner passed away before or after their RBD.

The SECURE Act also created a new category of eligible beneficiaries called “eligible designated beneficiaries,” such as surviving spouses, minor children, disabled individuals, and chronically ill individuals. These beneficiaries maintain the ability to stretch distributions over their own life expectancy, offering more flexibility.

With all this information, it is no wonder why many individuals, including myself, still find themselves confused when it comes to inheriting an IRA. The IRS guidance aims to provide clarity, but the intricate rules and constant changes make it hard to grasp for the average taxpayer.

If you find yourself in a similar situation, seeking professional advice from a financial advisor or certified public accountant who specializes in retirement planning can greatly assist in understanding the regulations and creating a suitable strategy for your inherited IRA.