IRA beneficiaries: Spouse vs. non-spouse
The coronavirus relief bill, or CARES Act, enacted last March had a significant impact on inheritors of IRAs.
For spouses, not much changed. For example, the stretch option remains for widows and widowers of IRA holders. If a spouse inherits an IRA, she can still roll over the IRA into her own IRA. There are several advantages in doing so. By maintaining the funds in their own IRA, the spouse can continue to stretch the withdrawals from the IRA over her life expectancy.
Unfortunately, for most non-spouse beneficiaries, this option has been removed. If the inheritance was executed in 2020 or later, the funds must be withdrawn over a 10-year period. In the first nine years after the inheritance, no withdrawals are compulsory. However, by the end of the 10th year, all of the funds in the IRA must be withdrawn. Even though withdrawals are not required in years one through nine, you may want to make partial withdrawals in order to avoid a large tax liability in the 10th year if you made no previous withdrawals.
As a non-spouse beneficiary, if you inherited an IRA prior to 2020, you are still allowed to stretch out withdrawals based on your life expectancy. If you elect this option, then you must make RMD withdrawals based on the IRS Table 1 (See IRS publication 590-B). If you prefer, you can use the five-year rule. Under this rule, you can withdraw any amount at any time within the fiveyear period. With the five-year rule, all assets must be withdrawn by Dec. 31 of the year containing the fifth anniversary of the IRA owner’s death. If you inherited a large amount of money, to avoid a large income tax bill, you should use the life expectancy option rather than the five-year option.
Here are some other rules to be aware of:
Nonspouses who have established an inherited IRA account, even if they have not reached 59 1⁄2, are not subject to a 10% early withdrawal penalty. If you are a
Early withdrawal penalty:
spouse, younger than 59 1⁄2, and intend to make withdrawals from a traditional inherited IRA, you should establish an inherited IRA. Then you are allowed to make withdrawals without the early withdrawal penalty. When you do reach age 59 1⁄2, at that point you can roll over the account into your own IRA.
Additional contributions: If you inherited the IRA as a non-spouse, you are not allowed to make additional contributions to the inherited IRA. As the spouse, once you have rolled over the account to your own IRA, you can make additional IRA contributions to the account as long as you have earned income.
Conversion to Roth: If you inherited a traditional IRA from your spouse, you have the option of converting your IRA to a Roth whenever you wish. As a nonspouse, you do not have that option; you cannot convert an inherited IRA to a Roth IRA account.
Changing custodians: Whether you are a spouse or a non-spouse, you have the option to change custodians for any reason. You may want to do that because of cost, investment options or any other reason. If you inherited as a spouse, you can roll over the account. If you inherited as a non-spouse, you only have the option to do a direct transfer of assets from one custodian to another one.
Qualified charitable distributions: Whether you inherited the IRA as a non-spouse or a spouse, you have the option to make charitable contributions directly from your trustee to a qualified charitable organization. This option, known as a QCD, provides you with a tax advantage only if you are required to make required minimum distributions because of your age (at least age 70 1⁄2).
Successor beneficiaries: Both spouses and non-spouses should establish successor beneficiaries with the custodian of the IRA account.