Inherited IRAs Are Getting Complicated -- What Investors Need to Know Before Passing Them On

There was a time when all IRA beneficiaries could spread required minimum distributions (RMDs) out over their lifetime, based on their age and life expectancy. However, thanks to the SECURE Act, there are new rules surrounding inherited IRAs. If you plan to leave an IRA to someone you care about, here's what you -- and they -- should know.

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Surviving spouse

If you're married, your surviving spouse has options unavailable to non-qualifying beneficiaries. They include:

• Roll the money over: A surviving spouse under 73 (or 75 if born in 1960 or later) can transfer the traditional or Roth IRA into their own name. If it's a traditional IRA, your spouse can delay required minimum distributions (RMDs) until they're 73 (or 75), giving the money more time to grow tax-deferred. If it's a Roth IRA, there is no RMD for the spouse to deal with.
• Take a lump-sum distribution: Your spouse can choose to withdraw the entire account balance. If it's a traditional IRA, the funds are taxed as ordinary income, which may push your spouse into a higher tax bracket. If it's a Roth IRA and you held the account for at least five years, all withdrawals will be tax-free to your beneficiary.

• Open an Inherited IRA, Life Expectancy Method: Your spouse may transfer assets into an Inherited IRA or an Inherited Roth IRA. Choosing this option means your spouse must begin taking RMDs by Dec. 31 of the year after your death. These RMDs will be based on your spouse's life expectancy.

Other eligible designated beneficiaries

There is another small group of beneficiaries who are not subject to the 10-year rule or RMDs. These beneficiaries may be permitted to "stretch" RMDs based on their life expectancy. They are:

• Your minor children (until age 21)
• Disabled or chronically ill individuals
• Beneficiaries no more than 10 years younger than you

Non-qualified beneficiaries

You're free to leave an IRA to anyone you would like; however, unless they're a spouse or other eligible designated beneficiary, they'll need to follow a stricter set of rules. These rules include:

• 10-year rule: Most non-spouse beneficiaries who inherit an IRA from you must fully delete the account within 10 years of your death. This rule applies to both traditional and Roth IRAs.
• Income taxes: Traditional IRA distributions are taxed as ordinary income. However, because your contributions to a Roth IRA are made with money you've already paid taxes on, your beneficiaries won't have to pay taxes on it again.
• If you've already begun taking RMDs before you die: Your beneficiaries must take RMDs in the first nine years following your death, based on their life expectancy. If there's any money left in the account, they must withdraw the remaining balance by the end of the 10th year.
• If you die before reaching RMD age: Annual distributions are not required. However, the account must still be fully emptied by year 10.
• Risk of penalty: If a beneficiary misses the 10-year window, they could face a 25% penalty on the amount they failed to withdraw. For example, if there were $10,000 left, they might face a $2,500 excise tax.

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