When you inherit an IRA, you may be required to empty the inherited IRA within a specified period. The SECURE Act of 2019 introduced the 10-year rule for inherited IRAs, which requires funds to be fully distributed by the 10th year after the death of the original IRA holder. However, there are certain exceptions to this rule.
Beneficiaries who qualify as eligible designated beneficiaries are exempted from the 10-year rule for inherited IRAs. These beneficiaries include surviving spouse(s), minor children, disabled or chronically ill individuals, and individuals no more than 10 years younger than the original IRA holder. The exemption allows these beneficiaries to defer distributions over a longer period.
What is the 10-year rule for inherited IRAs?
The 10-year rule for inherited IRAs was introduced by the SECURE Act of 2019. The law requires most non-spouse beneficiaries to fully distribute the retirement assets in their inherited IRA within 10 years after the original IRA account holder’s death.
Before the 10-year rule was introduced, inherited IRA beneficiaries could stretch distributions over their life expectancy, allowing them to defer taxes indefinitely. However, with the 10-year rule, most non-spouse beneficiaries must fully distribute the retirement assets by the 10th year after the original IRA holder’s death to avoid penalties. This may mean taking larger taxable distributions within a shorter time frame.
The 10-year rule does not require mandatory annual distributions if the original IRA holder has not reached the RMD age. The beneficiary may decide to spread distributions over several years as long as the account is fully depleted by the 10th anniversary of the IRA owner’s death. However, be aware that taking large distributions could push you into a higher tax bracket, and you will owe more taxes on the distributions.
Exemptions to the 10-year rule
The 10-year rule applies to most non-spouse beneficiaries, but there are several exceptions. Certain beneficiaries may still be able to spread distributions over their life expectancy.
Here are some of the beneficiaries exempted from the 10-year-rule:
Surviving spouse
A surviving spouse enjoys more flexibility than non-spouse beneficiaries with regard to how inherited IRA funds are distributed. A surviving spouse can treat the inherited IRA as their own, by designating themselves as the owner or rolling over into their IRA. This option allows the spouse to delay taking distributions until they attain the RMD age. If the spouse is younger than the deceased IRA owner, delaying distributions allows the money more time to grow tax-deferred.
The surviving spouse can also choose to transfer the assets to an inherited IRA. This may be a good option if the spouse is below 59 ½ and wants immediate access to the inherited assets. Usually, the spouse can take penalty-free distributions from the inherited IRA but will still owe income taxes on the money. Once the surviving spouse attains age 59 ½, they can decide to transfer the inherited IRA into their own IRA.
Minor child
Minor children of the deceased IRA owner are exempted from the 10-year rule, allowing them to spread distributions over their life expectancy. This exemption allows them to access the funds needed for their education and living expenses until they reach maturity.
However, once the minor child reaches the age of majority, the 10-year rule kicks in, and they will be required to fully distribute the inherited IRA within 10 years. They can spread distributions over several years or take a lump sum distribution before the 10th year.
Disabled or chronically ill
Beneficiaries who meet the criteria for disabled and chronically ill are exempted from the 10-year rule, and they can spread distributions from an inherited IRA over their life expectancy. Disabled and chronically ill individuals qualify as eligible designated beneficiaries, allowing them to extend distributions beyond the 10-year window.
If the original IRA holder named a special needs trust with a primary beneficiary who qualifies as an eligible designated beneficiary, the trust is allowed to stretch distributions based on the beneficiary’s life expectancy. Hence, the trustee can manage the distributions to ensure beneficiaries receive enough funds for their care and living expenses, while still being eligible for government benefits.
Beneficiaries who are no more than 10 years younger than the original IRA holder
Beneficiaries who are close in age to the deceased IRA owner are not subject to the 10-year rule. To qualify for the exemption, the beneficiary must be no more than 10 years younger than the original IRA holder. These beneficiaries can spread distributions over their life expectancy. However, once they attain age 73, they will be required to start taking the required minimum distributions.
Are trusts subject to the 10-year rule?
When the original IRA holder names a trust as an IRA beneficiary, the distribution rules will depend on the type of trust and the beneficiaries named in the trust. Generally, the trust must qualify as a see-through trust, and it must meet several requirements including having identifiable beneficiaries, being irrevocable upon the IRA owner’s death, and providing documentation to the IRA custodian.
A see-through trust can take advantage of any exemptions to the 10-year rule available to its beneficiaries like minors and disabled individuals. There are two types of see-through trusts i.e. conduit trusts and accumulation trusts. Conduct trusts allow distributions to go directly to the beneficiaries, while accumulation trusts allow the trust to retain or distribute the inherited assets within the trust.
Trusts that do not meet the requirements of a see-through trust are subject to the 10-year rule, and must fully distribute the IRA by the 1th year of the original IRA holder’s death.