Tapping an Inherited IRA?
Many people are looking at their inherited IRAs this year, when COVID-19 has decimated the economy. The rules about when and how you can tap the money you inherited changed with the passage of the SECURE Act at the end of December 2019. It then changed again with the passage of the CARES Act in late March in response to the financial impact of the pandemic.
Things are different now, reports the article “Read This Before You Touch Your Inherited IRA Funds” from the News & Record, but one thing is the same: you need to know the rules.
First, if the owner had the account for fewer than five years, you may need to pay taxes on traditional IRA distributions and on Roth IRA earnings. This year, the federal government has waived mandatory distributions (required minimum distributions, or RMDs) for 2020. You may take out money if you wish, but you can also leave it in the account for a year.
Surviving spouses who don’t need the money may consider doing a spousal transfer, rolling the spouse’s IRA funds into their own. The RMD doesn’t occur until age 72. This is only available for surviving spouses, and only if the spouse is the decedent’s sole beneficiary.
The federal government has also waived the 10% early withdrawal penalty for taxpayers who are under 59½. If you are over 59½, then you can access your funds.
The five-year method of taking IRA funds from an inherited IRA is available to beneficiaries, if the owner died in 2019 or earlier. You can take as much as you wish, but by December 31 of the fifth year following the owner’s death, the entire account must be depleted. The ten-year method is similar, but only applies if the IRA’s owner died in 2020 or later. By December 31 of the tenth year following the owner’s death, the entire IRA must be depleted.
Heirs can take the entire amount in a lump sum immediately, but that may move their income into a higher tax bracket and could increase tax liability dramatically.
A big change to inherited IRAs has to do with the “life expectancy” method, which is now only available to the surviving spouse, minor children, disabled or chronically ill people and anyone not more than ten years younger than the deceased. Minor children may use the life expectancy method until they turn 18, and then they have ten years to withdraw all remaining funds.
There is no right or wrong answer, when it comes to taking distributions from inherited IRAs. However, it is best to do so only when you fully understand how taking the withdrawals will impact your taxes and your long-term financial picture.
Reference: News & Record (May 25, 2020) “Read This Before You Touch Your Inherited IRA Funds”
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