The passage of the SECURE Act in December 2019 altered the rules regarding distributions from inherited IRAs. The CARES Act, passed in March 2020, added an additional change applying specifically to 2020. To help you understand the implications, we’ve written this update to our July 2017 article, “Inherited IRA Rules for Spouses, Heirs and Trusts.”

There a few key things to keep in mind:

• Generally speaking, the date of death matters in terms of which rules are applied. The SECURE Act’s rules generally apply when the date of death is January 1, 2020, or later.
   
• The SECURE Act splits beneficiaries into one of three groups: 1) non-designated beneficiaries—charities, most trusts, etc.; 2) eligible designated beneficiaries—spouses, minor children, beneficiaries with a chronic illness or qualifying disability and see-through trusts; and 3) (non-eligible) designated beneficiaries—an individual who is a designated beneficiary but not an eligible designated beneficiary (Figure 1).
   
• The 10-year rule, when applicable, eliminates required minimum distributions (RMDs) but requires the inherited IRA’s assets be fully distributed by the end of the 10th calendar year following the date of death (e.g., December 31, 2030, for an IRA whose owner died in 2020).
   
• The required beginning date (RBD), when applicable, is age 70½ for decedents who would have reached this age in 2019 or earlier and age 72 for all other decedents.
   
• The CARES Act waived RMDs from inherited IRAs for 2020.

One thing that has not changed is the unique traits of inherited IRAs, which do not follow all of the same rules as traditional individual retirement accounts and Roth IRAs.

Though some similarities exist, the applicable rules are dependent on whether the new owner of the account was married to the deceased. Even when the surviving spouse inherits the deceased’s IRAs, the applicable rules are dependent on the designation chosen.

The rules are not overly complicated but must be paid attention to and followed. If they are not, tax penalties can be levied. In this article, the rules for surviving spouses, non-spouses and trusts are explained. Those seeking further information should read IRS Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs). (Click here for a list of resources with information about the impact of the SECURE Act on inherited IRAs.) A consultation with an estate attorney and/or a tax professional is advisable for questions regarding specific situations.

Before discussing the rules, there is one important point to make. Keeping beneficiary information correct and updated is of key importance. Not doing so can cause unintended or unwanted complications for one’s spouse and heirs. Even if beneficiaries have previously been named, ensure that the information is updated, correct and matches other estate planning documents. (For example, if you’ve created a trust for the IRA to go into, ensure that the trust is correctly named as a beneficiary on the IRA.)

General Rules Regarding Inherited IRAs

Investments held within an inherited IRA grow tax-free. Taxes are levied at the time that withdrawals are made from an inherited IRA; such withdrawals are generally taxed at ordinary income tax rates and are generally not subject to the 10% early withdrawal penalty for beneficiaries. Exceptions include qualified withdrawals from an inherited Roth IRA (not taxed) and an early withdrawal from an inherited IRA that a spouse elects to become the owner of. (Becoming an owner generally makes the IRA subject to the early withdrawal penalty.)

The assets in the deceased’s IRA must be transferred into a new inherited IRA held in the beneficiary’s name. The assets must be transferred even if a lump-sum distribution is planned. Surviving spouses have the option of rolling over assets into their own account.

For owners who died in 2019 or earlier, RMDs must be taken from inherited IRAs and Roth IRAs if the owner had reached a certain age by the calendar year of their death. For owners who reached age 70½ by 2019 or earlier (a birthdate of June 30, 1949, or earlier), beneficiaries must take the deceased’s RMD for the year of the death. For example, say Joseph was age 71 when he died in 2019 and had yet to take his full 2019 RMD. His wife, Sandra, inherited the IRA and must have taken Joseph’s full required minimum distribution no later than December 31, 2019. The amount is what Joseph would have been required to take had he lived for the entire calendar year.

If Joseph had instead turned age 70½ in January 2020 and died, say, in February 2020, the SECURE Act’s rules would apply. Eligible designated beneficiaries would start taking RMDs in 2021 when Joseph would have turned 72 unless his surviving spouse, Sandra, made the IRA her own. (In this case, RMDs would be based on Sandra’s age.) The 10-year rule would apply to non-eligible designated beneficiaries. Non-designated beneficiaries would continue to follow the five-year rule or the decedent’s life-expectancy rule, as they were required to do prior to the SECURE Act.

April 1 of the year following the year a person reaches age 70½ (or 72 for those who turned/would have turned age 70½ in January 2020 or later) is the required beginning date for taking mandatory distributions. If Joseph died prior to reaching this age, no RMD would be required in the year of his death.

When RMDs are required (outside of the 10-year rule), they are based on the Internal Revenue Service’s life expectancy tables. These tables can be found in IRS Publication 590-B, though your broker may do the calculations for you. Beneficiaries can withdraw amounts greater than the required amount, including the full balance.

Alternatively, under the five-year rule, beneficiaries must withdraw the full IRA balance no later than December 31 of the year containing the fifth anniversary of the owner’s death (e.g., 2025 for a person who died in 2020). Distributions, including a lump sum of the account’s balance, can be taken at any point before the deadline. The deadline for electing to use this rule is the earlier of December 31 of the fifth anniversary year or December 31 of the first year the beneficiary must take RMDs based on their life expectancy.

The five-year rule never applies if the account owner died on or after their required beginning date for distributions. This date is April 1 of the year following the year the account owner reached the age of 70½ if this age was reached by December 31, 2019. The required beginning age is December 31 of the year the account owner turned 72 for those who reached age 70½ on or after January 1, 2020 (a birthdate of July 1, 1949 or later).

Failure to take the full required distribution from an inherited IRA can result in a 50% tax being levied against the amount not distributed, as required by the tax code.

Inherited IRAs do not receive the same protections as retirement accounts under the bankruptcy code. In writing the opinion for a unanimous 2014 U.S. Supreme Court decision, Justice Sonia Sotomayor described the funds held within inherited IRAs as being not set aside for retirement and therefore not qualifying as retirement assets. (See “Supreme Court: No Bankruptcy Protection for Inherited IRAs” in the Dispatches section of the July 2014 AAII Journal for more about the ruling.) Exceptions to this ruling exist if state law specifically grants protection to such accounts. (See “State Law May Protect Inherited IRA Assets From Creditors” in the Dispatches section of the April 2019 AAII Journal.)

Who Is the Beneficiary?

The IRS says the designated beneficiary is generally determined on September 30 of the calendar year following the calendar year of the IRA owner’s death. Designated beneficiaries must be listed as a beneficiary as of the date of death.

A person who was designated as a beneficiary as of the date of death but disclaimed entitlement prior to the September 30 deadline will not be taken into account for purposes of determining the designated beneficiary. Should the beneficiary die before the deadline without disclaiming, the deceased individual will continue to be treated as the beneficiary for determining how the IRA’s funds must be distributed.

In all cases where there is no individual designated beneficiary by September 30 of the year following the owner’s death, the five-year rule for withdrawal applies. If any beneficiary is not an individual (e.g., the estate is the beneficiary), the five-year rule generally applies.

What Happens If the Beneficiary Dies?

Should a beneficiary die before the entire sum of their inherited IRA is withdrawn, under the old rule, the deceased beneficiary must continue to take withdrawals based on the deceased beneficiary’s schedule in general. If Chris is the beneficiary of an inherited IRA and he dies, the heirs he designated as his beneficiaries will become successor beneficiaries to the inherited IRA. These successor beneficiaries will not be able to recalculate the RMDs, however. Rather, because Chris was already a designated beneficiary of the inherited IRA, the RMDs will continue to be calculated based on his life expectancy. The SECURE Act changed these rules.

An example explains how. Say the owner of the IRA that Chris inherited died in April 2018 and Chris himself died before September 30, 2019, without disclaiming his entitlement to the inherited IRA’s benefits?the old rule applies. Chris’ beneficiaries would become successor beneficiaries and the RMDs will be calculated based on Chris’ life expectancy. If Chris died in 2020 or later, the SECURE Act’s 10-year rule would apply to the beneficiaries.

The rules differ when the surviving spouse is the one who died. If Sandra were to die before December 31 of the year she must begin taking RMDs from her late husband Joseph’s IRA, she will be treated as if she was the owner of the IRA if she did not make Joseph’s IRA her own IRA.

In the event the surviving spouse remarries, this rule does not apply to their surviving spouse. Rather, the surviving spouse of a surviving spouse is treated as a beneficiary instead of an owner of the inherited IRA. Say Sandra remarries and names her second husband, Mike, as the sole beneficiary on the IRA she inherited from her first husband Joseph. Sandra then dies before she is required to begin taking distributions from Joseph’s IRA. Under the old rules, Mike must take distributions from the inherited IRA based on his own life expectancy or elect to fully withdraw all of the assets under the five-year rule. If Sandra died in 2020 or later, the 10-year rule would apply to Mike for the inherited IRA.

Inherited Roth IRAs

Distributions from a Roth IRA are qualified if they are taken after a five-year period beginning with the first taxable year in which the contributions were made and those distributions are made to a beneficiary or to the deceased’s estate. A distribution would not be qualified if the account holder died before five years have passed since the first taxable year in which the contribution was made or before five years after a Roth IRA conversion occurred.

Non-qualified distributions from an inherited Roth IRA are taxable to the extent they are earnings instead of the recovery of the owner’s original contributions but are not subject to the 10% early distribution penalty.

Under the SECURE Act, Roth IRA assets must generally be distributed within 10 years unless the surviving spouse is subject to the aforementioned groups of beneficiaries.

Surviving Spouse Inherits IRA

If the person inheriting the IRA was married to the deceased, the options for handling the account (assuming the benefit is not disclaimed) are:

• Designate oneself as the account owner;
• Roll it over to one’s own IRA or, to the extent it is taxable, into a qualified employer plan [e.g., a 401(k) plan, 403(a) plan, 403(b) plan or 457 plan];
• Treat oneself as the beneficiary rather than treating the IRA as their own; or
• Withdraw the entire balance from the account (taxes and additional penalties may apply).

To simplify the explanation, we’ll stick with our fictional couple: Joseph and Sandra. Joseph dies and Sandra is the surviving spouse. (If Sandra were to die first instead, the same rules would apply to Joseph.) Unless explicitly stated otherwise, the IRA discussed is a traditional IRA.

If Sandra makes a contribution to Joseph’s IRAs, or if she does not take the RMD for a year as the beneficiary, she will be considered to be the owner of Joseph’s IRA. In the eyes of the IRS, Sandra will only be considered to have chosen to treat Joseph’s IRA as her own if she is the sole beneficiary and she has an unlimited right to withdraw funds from it.

As the surviving spouse, Sandra has the option to roll over any distribution from Joseph’s IRA that is not an RMD to her own IRA if she is a beneficiary instead of the owner of the account. Like other rollovers, the distribution must be put into Sandra’s account within 60 days if a trustee-to-trustee (e.g., broker-to-broker) transfer is not done. The rollover is not a taxable transaction. Keep in mind that RMDs from any IRA cannot be rolled over or otherwise deposited into another IRA account and are considered to be taxable income.

Little changed under the SECURE Act for surviving spouses. The surviving spouse is an eligible designated beneficiary and can either roll over the deceased spouse’s IRA to their own IRA or treat it as an inherited IRA. If the latter, the surviving spouse is not subject to the 10-year rule but rather can spread distributions over the course of their lifetime.

RMD Rules for Surviving Spouses

As previously stated, if the owner dies on or after April 1 of the calendar year when they turned 70½ (or 72 if age 70½ is reached 2020 or later), the account’s beneficiaries must take the deceased’s required minimum distribution in the year of the death. For example, if Joseph dies in 2019 at age 72 and had yet to take his full RMD for 2019, Sandra would have had to take Joseph’s full RMD no later than December 31, 2019.

If, instead, Joseph turned 70½ in February 2020 and died in March 2020, no RMD would need to be taken in 2020. Two rules dictate why, for two different reasons. The SECURE Act raised the age for starting RMDs to 72 for those who reached age 70½ in January 2020 or later. The CARES Act waived RMDs for the 2020 calendar year.

The rules regarding future RMDs depend on whether the surviving spouse is the owner or the beneficiary of the account.

If Sandra is the sole beneficiary of Joseph’s account and elects to be treated as the owner, the calculation for future RMDs will change to treat her as being the owner beginning with the year she elects or is deemed to be the owner. This does not change what was stated two paragraphs ago, however. Any RMD the deceased would have had to take for the calendar year of death will still need to be taken. In this case, the RMD for 2019 would be what Joseph would have been required to take; in 2020, the RMD switches to calculations based on Sandra’s age (though the RMD for 2020 would be waived). If she is below the age of 70½ in any year from 2019 forward, as the account owner she will not have to take RMDs until she reaches age 72. If Sandra is below the age of 59½, a 10% penalty will generally be levied on any withdrawals if she elects to be the account owner.

If Sandra is the sole beneficiary but not the owner of the IRA, then the date of death matters.

If Joseph died in 2019 or earlier, the beneficiary rules for RMDs apply. Beneficiaries must take distributions starting the year after the year of the IRA owner’s death (2019, if Joseph had died in 2018). These distributions must be taken by December 31. The RMDs will be based on Sandra’s attained age for each year. If she is younger than 59½ and has not rolled over Joseph’s IRA, Sandra would be able to take the distributions from the inherited IRA without incurring the 10% penalty that would otherwise apply to early withdrawals. She still would retain the option to roll over the inherited IRA to her own account after taking RMDs from the inherited IRAs. (The amount eligible for the rollover excludes the RMD for that year.)

If Joseph dies in 2020 or later, Sandra would be considered an eligible designated beneficiary. She would need to start taking RMDs for the year when Joseph (the deceased spouse) would have turned age 72.

Roth IRA Rules for Surviving Spouses

Surviving spouses who are the sole beneficiary of a Roth IRA can elect to treat the Roth IRA as their own. By electing to take ownership, Sandra would then be able to combine Joseph’s Roth IRA with her own Roth IRA. Were Sandra to simply stay as beneficiary instead, she would follow the same RMD rules that apply to traditional IRAs.

Surviving spouses who are the sole beneficiary of a Roth IRA can also delay distributions until the decedent would have reached age 70½ if by the end of 2019 or age 72 if in 2020 or later. Distributions can also be delayed if the surviving spouse treats the Roth IRA as their own.

Someone Other Than the Spouse Inherits the IRA

There are key differences in the rules for beneficiaries who were not married to the deceased. The tax code gives non-spousal beneficiaries less flexibility than it does surviving spouses. Such beneficiaries cannot treat the IRA as their own. Contributions cannot be made to the inherited IRA. The inherited IRA cannot be rolled over to a beneficiary’s IRA. Trustee-to-trustee transfers (e.g., from one brokerage firm to another) must be done in the name of the deceased owner for the benefit of the beneficiary.

More Than One Beneficiary

Splitting the IRA into more than one account has advantages in cases where there is more than one beneficiary. It avoids potential disagreements about how the inherited IRA should be managed. It simplifies any legal issues involving one or more—but not all—of the beneficiaries. Plus, under the old rules, splitting the IRA into more than one account allows each beneficiary to use their own life expectancy for calculating the required minimum withdrawal.

Under the SECURE Act’s new rules, splitting makes sense when one or more—but not all—of the beneficiaries fall under the same classification. An example would be where one beneficiary is a minor, but the others aren’t. The beneficiary who is a minor would qualify as an eligible designated beneficiary and would not be subject to the 10-year rule until they reach the age of majority. The other, older beneficiaries would be non-eligible designated beneficiaries (assuming they don’t otherwise qualify as an eligible beneficiary), and the 10-year rule would immediately apply to them.

Each beneficiary must establish their own account under their own name. The accounts cannot be commingled. Once these accounts are established, each beneficiary can choose who they want to list as their beneficiaries. If a non-eligible designated beneficiary dies before all of the assets in the inherited IRA are withdrawn, their 10-year period for taking withdrawals carries over to their successor beneficiaries; the 10-year period is not restarted for the successor beneficiary.

The deadline for establishing multiple accounts is December 31 of the year following the year of the owner’s death (e.g., December 31, 2020, for an IRA of someone who dies in 2019). If separate accounts are not established by this date and all the beneficiaries are individuals, one of two rules applies depending on the date of the owner’s death. If the decedent died in 2019 or earlier, RMDs for all beneficiaries will generally be based on the life expectancy of the oldest beneficiary. (The shortest life expectancy rule applies when there is more than one beneficiary as of September 30 in the year following the owner’s death.)

If the decedent died in 2020 or later, the SECURE Act’s 10-year rule generally applies. The beneficiaries must take the distributions within 10 years. (Contact an estate attorney if one or more of the beneficiaries is not a non-eligible designated beneficiary.)

The separate account rules cannot be used by beneficiaries of a trust.

Non-Spousal Rules for Inheriting a Roth IRA

As is the case with a traditional IRA, inherited Roth IRA assets must either be withdrawn in accordance with the five-year rule or through the same RMD rules that apply to traditional IRAs. The SECURE Act’s 10-year rule generally applies if the decedent dies in 2020 or later.

Exceptions to the SECURE Act’s 10-year rule apply to individuals are who are a minor in the state of their residence and a child of the deceased, qualify as being disabled according to the tax code, are considered chronically ill according to the tax code or are not more than 10 years younger than the deceased. In such cases, the older rules of using either the five-year rule or the RMD rules apply. Once a minor turns the age of majority for their state (generally 18), they must withdraw the inherited assets within 10 years.

A Trust Inherits the IRA

The IRS lists specific rules describing what a qualified trust is:

1. The trust must be valid under state law, or would be for the fact that there is no corpus;
2. The trust is irrevocable or becomes irrevocable upon the owner’s death;
3. The trust’s beneficiaries are identifiable from the trust instrument; and
4. The trustee of the trust provides the necessary documents to the IRA custodian or trustee (e.g., the brokerage firm). This documentation must be provided by October 31 of the year following the death of the IRA’s owner.

A new inherited IRA account will need to be opened in the name of the original account owner for the benefit of the trust. Note that the beneficiaries of the trust will not be able to open their own inherited IRAs. Rather, they will receive distributions from the trust’s trustee.

Since a trust cannot be a designated beneficiary, RMDs will be based on the trust’s beneficiaries. The trust’s beneficiaries will be treated as having been designated beneficiaries in this instance.

Say Joseph instructed his broker to name his trust as the beneficiary of his IRA. The trust itself lists his wife Sandra as its beneficiary. For estate planning purposes, the IRA goes into the trust.

Again, there are split rules regarding distributions. The older rules, which apply to IRAs whose account owner died in 2019 or earlier, state that the trust cannot be used for calculating RMDs since it is not allowed to be a designated beneficiary. So instead, Sandra—the trust’s beneficiary—is treated as being the designated beneficiary for purposes of calculating the RMD.

If a second trust is the beneficiary of the first trust and meets the aforementioned rules, the beneficiaries of the second trust will be treated as being designated beneficiaries for purposes of calculating RMDs.

The SECURE Act’s 10-year rule applies to most trusts with a non-spouse beneficiary when the IRA’s account owner dies in 2020 or later. There are nuances in the rules applying to conduit and accumulation trusts. Questions about them and how the inherited IRA rules apply to other types of trusts should be directed to an estate attorney. ?

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