Important Rule Changes for Inherited IRAs

I’ve been receiving a lot of questions about inherited IRAs from my Women & Money podcast listeners.

And that’s understandable, as the withdrawal rules have changed and the IRS has added to the confusion with a new proposal.

Here’s what you need to know about inherited IRAs.

If you inherit(ed) an Individual Retirement Account (IRA) on Jan 1, 2020 or later and you were not married to the deceased, I want to make sure you are aware of some important rule changes for how quickly you must withdraw money from the account.

Up until 2020, anyone who inherited an IRA was only required to make annual required minimum distributions based on their life expectancy. In tax lingo, this was known as a stretch IRA, because you could stretch withdrawals over your life expectancy. (To be clear, you could also withdraw it all at once if you wanted. Or in chunks whenever you wanted.)

That’s now changed. Only spouses are able to continue to use the stretch IRA method. Everyone else who inherits an IRA now has a maximum of 10 years to withdraw all the money from an IRA. (There are exceptions to this for minor children who inherit an IRA, people who are disabled or chronically ill, and if the person inheriting the IRA is no more than 10 years younger than the deceased.)

I want to be crystal clear: If you inherited an IRA before 2020 and were not the spouse, you are still able to use the stretch IRA method. The new rules only apply to people who inherit an IRA after 2019.

The details:

Spouses. Nothing has changed. You can assume ownership of the IRA, and you can even continue to make additional contributions to the IRA. The required minimum distributions are based on your life expectancy, or if the deceased was younger, you can base it on his/her life expectancy.

Non-Spouses. This is where things have changed. When you inherit an IRA, you must withdraw all the money within 10 years. It’s actually more like 11 years; the way the IRS regulation works is that the 10-year clock starts no later than December 31 of the year after the account owner died. That 10-year window effectively eliminates the “stretch” strategy.

If what you inherit is a traditional IRA, you will owe tax on the withdrawals. If it is a Roth IRA, there will not be tax on the contributions the deceased made. And as long as the original Roth account has been around for at least five years, there will be no tax on the earnings in the account. That said, you still must withdraw the money from the Roth (and thus lose the ability to have the money continue to grow tax-free for you. However, nothing is stopping you from reinvesting your withdrawal in a regular Roth IRA, assuming you meet the income limits.)

Now here is where it gets tricky. Even if you want to wait a few years, or 10 years to empty the account, you may need to make annual required minimum distributions during your 10-year window. The IRS recently proposed that you should still be taking annual required minimum distributions (RMDs) each year. There is plenty of confusion about this among retirement/tax experts, as the IRS has issued the proposed rule, but it hasn’t formally been added to IRS tax regulations.

Ed Slott, a noted retirement tax expert, says he expects it will indeed become a regulation. But for those of you who didn’t realize you needed to take an RMD for 2021, sit tight. His advice is that the IRS is aware of the confusion, and he expects the IRS will propose some guidance before the end of the year on whether/how to handle a missed 2021 RMD.

I promise to keep you up to date when the IRS clarifies what is required.