What You Need to Know About Successor Beneficiary IRAs
Retirement accounts are intended to provide income during one’s retirement and are typically transferred to a beneficiary upon the death of the account owner. But what happens when the beneficiary dies before fully distributing the inherited retirement account?
When the owner of an Inherited IRA dies, the named beneficiaries on the Inherited IRA becomes a successor beneficiary. In other words, the individual is inheriting an IRA that has previously been inherited by someone else. For this reason, the account is often referred to as a Successor Beneficiary IRA.
The successor beneficiary becomes subject to specific IRS distribution rules and timelines governing when the remaining assets must be distributed.
Rules Addressing When the Original IRA Owner Names their Spouse as Beneficiary
When a spouse is named beneficiary of an IRA, they can either roll the IRA into their own IRA or keep it as an Inherited IRA. If the spouse rolled it into their own IRA, you are inheriting it as the primary beneficiary and not as a successor beneficiary. If the spouse instead kept it as an Inherited IRA, then the successor beneficiary rules discussed in this article apply.
Distribution Rules Depend on Several Factors
The SECURE Act of 2019 made significant changes to the required minimum distribution (RMD) rules that dictate when distributions must be made from retirement accounts. We therefore must start by knowing the following:
- Date of Birth and Date of Death of the Original Account Owner
- Date of Birth and Date of Death of the Original Beneficiary
Then you can determine which scenario applies to your circumstances.
Scenario 1 – Both the original owner and the original beneficiary died before 1/1/2020
Pre-SECURE Act rules apply. The successor beneficiary “steps into the shoes” of the original beneficiary and continues distributions under the original beneficiary’s distribution schedule. The SECURE Act’s 10-year rule does not apply.
Scenario 2 – The original owner died before 1/1/2020 and the original beneficiary died after 1/1/2020
The successor beneficiary “steps into the shoes” of the original beneficiary and continues distributions under the original beneficiary’s schedule. In addition, the SECURE Act’s 10-year rule applies, requiring the account to be fully distributed within 10 years.
Scenario 3 – Both the original owner and the original beneficiary died after 1/1/2020
Under the SECURE Act, the successor beneficiary generally “steps into the shoes” of the original beneficiary and continues the distribution method and timetable already in place for the original beneficiary.
Depending on the status of the original beneficiary and whether the original owner died before or after their required beginning date, (the date when the original owner’s required minimum distributions must have started), the successor beneficiary may:
- Be required to take annual distributions,
- Be subject to a 10-year distribution period, or
- Be subject to both annual RMDs and a 10-year payout requirement.
Distributing Faster
These rules address the MINIMUMS that must be distributed each year. The beneficiary can always opt to distribute faster. For example, when a 10-year timeline is in place, the account may be distributed any time prior but MUST be distributed by the last day of the 10th year to avoid IRS penalties. Each year you can take more of your minimum if you wish, or even fully empty the account. If you follow the minimum distribution rules, however, you will probably have a large amount remaining in the account that needs to be distributed in the 10th year, possibly putting you into a higher tax bracket. Taking an amount more than your required amount each year can be a helpful tax-saving strategy, depending on your circumstances.
Taxation
Distributions from a Successor Beneficiary IRA are generally subject to income tax. If the original IRA was funded with pre-tax contributions, distributions are typically taxable to the successor beneficiary in the year the funds are withdrawn.
Inherited Roth IRAs
The rules above apply to Roth IRAs as well as traditional IRAs, with a few exceptions. It is possible for a successor beneficiary who inherits both a traditional Inherited IRA and a Roth Inherited IRA, to have different withdrawal rules for each and should be reviewed carefully.
Generally, the distributions from Successor Beneficiary Roth IRAs are income tax-free, assuming the initial Roth IRA account met certain requirements.
Different Rules for Inherited 401(k)s
Inherited 401(k)s may have different rules, depending on the 401(k)’s plan document. 401(k)s are company plans, established by the original 401(k) owner’s employer. Contact the employer or plan administrator for the 401(k) for details. Their phone number should be on each monthly or quarterly statement.
How Your Financial Advisor Can Help
Because Successor Beneficiary IRA rules can vary significantly depending on the dates of death, the type of beneficiary, and whether the original owner had reached their required beginning date, these accounts can quickly become complicated. Mistakes in handling distributions may lead to unnecessary taxes or IRS penalties. If you inherit an inherited IRA, your financial advisor can help you to understand your options, meet required deadlines, and develop a distribution strategy that aligns with your overall financial goals. If you would like to learn more about how we can help you, please contact us.
