Managing the IRA you just inherited can be complicated because this area of the law has recently changed.
It used to be that no matter who you were – a surviving spouse, a child, a sibling, or friend of someone who passed away – you were usually only required to withdraw a certain amount of money each year based on your life expectancy (also referred to as your “minimum required distribution”), from an inherited IRA over the course of your lifetime. In most situations, this meant that you could hold the account for a significant period of time provided that you withdrew your minimum required distribution every year. This allowed individuals to have a more predictable and long-term view of cash flow and tax obligations.
Now, however, the rules regarding inherited IRA’s split people up into three different categories and apply different rules depending on who you are. If you inherit an IRA from a spouse, there is no real change, as you will be able to treat the IRA much as you would have under the old rules – with the option to take your minimum required distributions over your life expectancy.
Next, there are Eligible Designated Beneficiaries (EDB’s). These include beneficiaries who are minor children of the account holder, those who are chronically ill, those who are permanently disabled, and those that are not more than 10 years younger than the original account holder. EDB’s generally have three options available to them: in addition to being able to take distributions over the course of their life expectancies, they can take out the IRA assets over the course of ten years, or they can take out the entire account in one lump sum. The exception among EDB’s is a minor child. Once a minor reaches the age of majority, he or she must take money out of the IRA over the course of 10 years.
The most significant changes relating to IRA distributions occurs with the third category. If you are a designated beneficiary who is not a spouse, or who does not meet the requirements to be considered an EDB, you are required to fully take out all the money from the inherited IRA by the end of the tenth year after the account holder passed away.
For many people, fully distributing an IRA within 10 years can drastically impact their tax planning – whether it involves taking distributions every year or letting the IRA continue to grow for ten years before taking it out in one big lump sum. For those unprepared, it can lead to a serious surprise when taxes come due.
To minimize taxes and to achieve the best outcome for the beneficiaries of your estate, planning and talking about these issues with your estate planning attorney and your financial advisor is important.