The Secure Act has brought changes to the rules surrounding inherited IRAs and 401(k)s. Most beneficiaries will no longer be able to utilize the stretch IRA option but will instead have to follow the 10-year payout rule, which can lead to increased income taxes and a new set of Required Minimum Distribution regulations. Spouses are still able to benefit from the stretch IRA, but for non-spouse beneficiaries, the 10-year rule applies for inheritances received in 2020 or later.
It is essential to understand what type of beneficiary you are to determine the tax rules that apply to your inherited IRA. Non-designated beneficiaries and non-eligible designated beneficiaries are subject to the 10-year rule, while eligible designated beneficiaries can still use the stretch IRA. Making mistakes in handling this process can result in significant tax implications, potentially leading to losing up to half of your inheritance to taxes in California.
Taking a lump-sum distribution from the inherited IRA can result in substantial tax consequences, with as much as 50% of the inheritance being taxed at the top federal and state brackets. Spreading out withdrawals over 10 years can help keep taxes lower. Spouses inheriting an IRA have multiple options, including a spousal rollover, a stretch IRA, or following the 10-year rule, depending on their financial needs and age.
There is confusion among beneficiaries regarding the implementation of the Secure Act rules. Many are mistakenly being advised that they are not eligible for the stretch IRA, while others are being told they can benefit from it when they cannot. It is crucial to understand whether you are an eligible designated beneficiary to ensure you are following the correct withdrawal schedule and minimizing tax implications on your inheritance.
An eligible designated beneficiary is always an actual person and includes the deceased’s surviving spouse, children under 18, disabled or chronically ill individuals, and individuals not more than 10 years younger than the deceased IRA owner. EDBs can often withdraw from their inherited IRAs based on their life expectancy. Seeking guidance from a Certified Financial Planner and tax professional can help you navigate the rules surrounding inherited IRAs and develop a plan to minimize taxes on your inheritance.
