Understanding Your Options When Inheriting An IRA From A Non-Spouse

February 1st, 2017

Here’s another article from Adam Bergman that originally appeared on Forbes.com

Unfortunately, the Internal Revenue Service (“IRS”) does not allow you to keep retirement funds in your account indefinitely. The required minimum distribution rules (“RMD”) were created in order to guarantee the flow of IRA funds into the federal income tax system as well as to encourage IRA owners to use their retirement funds during their retirement.

One generally has to start taking withdrawals from your IRA, SIMPLE IRA, SEP IRA, or retirement plan account when reaching the age 70½ or as the beneficiary recipient of an inherited IRA. Of interest, Roth IRAs do not require withdrawals until after the death of the owner.

There are a number of distribution options available to a designated IRA beneficiary, generally dependent on whether the deceased IRA owner’s sole primary beneficiary is a spouse, and whether the deceased IRA owner has reach 70 1/2, the age for RMDs. Remember, a living IRA owner is not required to take an RMD until the IRA owner reaches the age of 70 1/2.

If an IRA holders dies and designates a non-spouse, such as a parent, child, sibling, friend, etc. as the primary beneficiary of his or her IRA, the non-spouse beneficiary will typically only have two options for taking RMDs with respect to the inherited IRA: (i) the life expectancy rule and (ii) the five-year rule.

The IRS allows a non-spouse beneficiary to use the life expectancy rules to calculate the IRA required distributions after the deceased IRA holder’s death. The IRA distributions must begin to be taken no later than December 31 of the year after the death of the deceased IRA holder’s death. There are no additional opportunities for delaying IRA distributions for non-spouse beneficiaries. If distributions are made under the life expectancy rule to a designated beneficiary non-spouse, the applicable distribution period for the calendar year immediately after the year of the IRA owner’s death is the beneficiary’s remaining life expectancy as of his or her birthday during that year and the applicable period is reduced by one for each subsequent distribution calendar year. Unlike in the case of a spouse beneficiary, which is required to use the life expectancy of the deceased IRA owner for purposes of calculating the annual RMD amount, a non-spouse beneficiary is required to use his or her life expectancy when calculating the annual required distribution amounts. For example, if Jane is designated as sole beneficiary of an IRA of her mother, who died during 2015, her first distribution calendar year is 2016. If Jane turned 60 years old during that year, the applicable distribution period would be based on the life expectancy of a 60-year-old. Conversely, the non-spouse beneficiary has the option to select a five-year distribution rule, which would required the non-spouse beneficiary to take the entire amount of the inherited IRA as a distribution over a five year period. Of note, a non-spouse IRA beneficiary does not have the option to convert the traditional inherited IRA to a Roth IRA.

The IRA custodian (the financial institution) is required to submit reports to the IRS and to the IRA owner regarding RMDs. If an RMD is required to be taken from an IRA for a calendar year and the IRA owner is alive at the beginning of the year, the IRA custodian that held the IRA as of December 31 of the prior year must provide a statement to the IRA owner to report the due date of the RMD and, in most cases, the amount that is due. The IRA custodian is required to send this report to the IRA owner by January 31 of the year for which the RMD is required.

The RMD rules and options for a non-spouse beneficiary can bring to bear some financial and tax implications. Therefore, it is important that one consults a tax professional or financial advisor for further guidance.

For more information about the Inherited IRA Rules, please contact us @ 800.472.0646.

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