Smart Strategies for Dealing With the IRA 10-Year Rule
Key Points
Some groups -- like surviving spouses -- are exempt from the 10-year rule.
Once withdrawn, every IRA dollar is treated as ordinary income.
It's a good idea to strategize a plan that leads to paying less in taxes.
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The SECURE Act of 2019 dramatically changed the rules governing inherited IRAs. Rather than stretch withdrawals from the IRA out over the course of your life expectancy, you may now be required to withdraw the entire balance by Dec. 31 of the 10th year following the original account owner's death.
Unless you're the surviving spouse, a minor child of the original account holder, are chronically ill, permanently disabled, or no more than 10 years younger than the original account holder, the 10-year rule applies to you.
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If you've inherited a traditional, rollover, SEP, or SIMPLE IRA and want to minimize the amount of tax you pay on the required withdrawals, consider the following strategies.
Some strategies that can help
- Build your plan around the type of IRA you inherit: If you inherit a traditional, SEP, or SIMPLE IRA, any funds you withdraw will be taxed as ordinary income. On the other hand, if you inherit a Roth IRA, no taxes will be due because the original owner made contributions with after-tax dollars. One option is to let an inherited Roth IRA ride -- allowing it 10 extra years to grow.
- Understand when you must take RMDs: Required minimum distributions (RMDs) are the government's way of collecting taxes on pretax contributions to retirement accounts. Most retirement account holders must begin taking RMDs at age 73 (or 75, if born in 1960 or later). If the person you inherited the IRA from was already taking RMDs, you must also take them in years one through nine. Failure to take an RMD could result in a 25% penalty on the amount that should have been withdrawn.
- Work around income: If you have a lower-income year, take a larger distribution. Save smaller (or no) distributions for years when your income is high. For example, if you receive a large bonus, cut way back on how much you withdraw. The idea is to avoid knocking yourself into a higher tax bracket.
- Even it out: If you typically earn around the same amount of money each year, consider spreading withdrawals evenly. Not only is a steady amount of money easier to budget for, but taking the same amount annually prevents you from having to take a lump sum in the 10th year.
- Know that you can opt out: If you're in great financial shape, don't need the IRA, and worry about getting pushed into a higher tax bracket, you have a right to disclaim the IRA. If you do so within nine months of the owner's death, it can be passed on to the next beneficiary.
An inheritance is an inheritance, and there's nothing wrong with someone leaving you an IRA -- even with the extra rules. The goal is to understand what's expected of you so you can create a plan that keeps as much of the money in the account as possible.
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