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Inhertied IRAs: It's Complicated

November 25, 2024 Author: Tess Downing, MBA, CFP®, Complete View Financial

Secure Act and SECURE 2.0.

Inherited IRAs: It’s Complicated

Several changes from the SECURE Act and SECURE 2.0 Act have made inheriting an IRA more complex. The stretch IRA, which allowed beneficiaries to take minimal distributions and defer taxes, has largely been replaced with a 10-year distribution requirement.

Understanding the Rules for Spouses
  • Surviving spouses have more flexibility: they can roll over inherited IRA assets into their own IRA and delay required minimum distributions (RMDs) until age 73.
  • If the spouse had begun RMDs before passing, any remaining RMDs must still be taken.
  • Spouses under age 59½ can use an inherited IRA to avoid the 10% early withdrawal penalty.
Understanding the Rules for Everyone Else
  • Eligible designated beneficiaries, such as minor children, the chronically ill, or those not more than 10 years younger than the original owner, can stretch distributions based on life expectancy.
  • Once minors reach age 21, they must fully distribute the account within 10 years.
  • Non-eligible beneficiaries must fully distribute inherited IRAs within 10 years.
How Non-Spouse Beneficiaries Can Create Tax Efficiency
  • Distributions should be timed for low-income years or during market downturns to minimize taxes.
  • Roth IRA withdrawals are tax-free, and letting the account compound for as long as possible may be beneficial.

Required Minimum Distribution Rules Have Been Updated

The IRS mandates required minimum distributions (RMDs) from retirement accounts to ensure taxes are paid on withdrawn funds. However, recent updates to the regulations have added complexities. Here’s what you need to know at a high level:

When Do RMDs Begin? How Should You Take Them?

  • RMD Starting Age
    • The current RMD age is 73, rising to 75 in 2033.
    • It is important to consider the impact of RMDs on taxes and overall financial planning.
  • RMD Withdrawal Timing
    • For those turning 73 in 2024, RMDs can be taken by December 31, 2024, or postponed until April 1, 2025.
    • Postponing results in two RMDs in 2025, affecting tax brackets.
  • Penalty for Missing RMDs
    • Failing to take RMDs results in a 25% penalty on the amount not withdrawn, plus regular taxes.
  • Special Rules for 401(k)s and IRAs
    • 401(k) plans require RMDs from each account, while IRAs allow taking the total RMD from one account.
  • Tax Planning Considerations
    • RMD timing affects Medicare benefits and could trigger higher taxes or Medicare surcharges.

Roth 401(k) Accounts Get Aligned with IRA Rules.
  • Similar to Roth IRAs, Roth 401(k) no longer requires RMDs, allowing funds to grow tax-free for the owner's lifetime.
Giving an RMD to Charity Got More Generous

  • Qualified Charitable Distributions (QCDs)
    • The QCD limit increased to $105,000 in 2024, turning taxable RMDs into tax-free charitable donations.
    • Couples can donate up to $210,000 without it being taxable income.

529 Plans and SECURE 2.0: More Flexibility

The SECURE 2.0 Act now allows unused 529 funds to be converted into a Roth IRA for the same beneficiary, up to $35,000, with certain conditions. The 529 plan must be open for at least 15 years, and recent contributions (within 5 years) are not eligible for conversion.

  • The Rising Cost of College
    • College costs have soared, raising questions about the cost/benefit of a degree. The Federal Reserve's interactive feature, The Labor Market for Recent College Graduates, examines 20 years of economic data on unemployment, underemployment, and wages by major.
    • Despite rising costs, college still offers significant benefits. In 2023, median salaries were $36,000 for high school graduates versus $60,000 for college graduates with a BA.
  • 529 Savings Plans: Key Benefits
    • 529 plans allow for tax-deferred growth of investments, and withdrawals for qualified education expenses are tax-free.
    • These plans are typically managed by states, and many states offer tax deductions or credits for contributions.
  • The Gift Tax Advantage
    • 529 plans have high aggregate limits, ranging from $235,000 to $550,000 (2023). Contributions over $18,000 in 2024 may trigger the gift tax unless spread over five years via the 5-Year Election.
    • "Superfunding" a 529 can quickly grow the balance and help with estate planning by sheltering funds from estate taxes.