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Inherited IRA Planning Opportunities

Posted by John Posey

Since the SECURE Act went into effect in year 2020, how most non-spouse beneficiaries can receive an IRA inheritance has changed. In the past, non-spouse beneficiaries could “stretch” an IRA inheritance (AKA Stretch IRA strategy) over their lifetime to spread out the tax liability of the IRA inheritance rather than take it all lump sum right away – a smart consideration for all that do not want to pay more in taxes than legally required. Unless you are an “eligible designated beneficiary” defined as a surviving spouse, minor child of the IRA owner (up to majority, or age 26 if still in school), disabled or chronically ill, or within 10 years of age of the IRA owner - the “Stretch IRA” is no longer an option.

All other non-spouse (non-eligible designated) beneficiaries will now use the 10-year rule. The inherited IRA must be fully distributed by the end of the 10th year after the year of death and there are no annual required minimum distributions (RMDs).

I recently came across an interesting article on the possibility of a surviving spouse choosing the 10-year rule, inherited IRA instead of a spousal rollover to an IRA of their own (which is often common practice) in efforts to suspend required minimum distributions. This could be a clever tax strategy for some, but the potential value of utilizing it depends on factors unique to the situation starting with the age of the original IRA owner and the age of the spouse beneficiary. For spouse beneficiaries, the payout options (ie - spousal rollover, 10-year rule or life expectancy “stretch”) are contingent upon whether the original IRA owner had reached their required beginning date (RBD), which is April 1 of the year after turning age 72. Practically speaking, if the original IRA owner was taking RMDs, spouse beneficiaries do not have the 10-year option. However, if the IRA owner had not reached their RBD and the spouse beneficiary is beyond age 72 (when RMDs apply), the 10-year option may be worth consideration and likely to prove more valuable the bigger the age gap between spouses and the more variability in projected taxpayer income from year to year. Long story short, if an IRA owner wasn’t required to take RMDs yet (i.e. – under age 72), the 10-year option may be worth considering for a surviving spouse.

A good next step would be considering the tax situation of the beneficiary spouse compared to the ultimate non-spouse beneficiaries, which is often the kids. If there are notable differences in income tax circumstances between the parties involved, it could make sense for the spouse beneficiary to realize more IRA income while living or pass on more IRA income at death given the situation, effectively utilizing a tax bracket management strategy.  If you don’t care to leave the IRS a tip, this kind of approach can help.

One final thought on inheriting a spouse’s traditional IRA. If the beneficiary spouse is younger than 59 ½ and wants the ability to take income they may want to consider going to an inherited IRA over a spousal rollover to an IRA of their own. The reason being there is no early withdrawal penalty applicable to inherited IRAs, which is a 10% penalty avoided upon distributions before age 59 ½.  On the flip side, you permanently forfeit Roth IRA conversion possibilities with those dollars if you use an inherited IRA over a spousal rollover to your own IRA. There are a few tradeoffs to consider.

Is your head spinning yet? Reach out to a reputable professional if these opportunities might be applicable to you and hash out the details. There are a lot of useful financial planning opportunities out there if only you’re aware of them or know someone who is.

Advisory services offered through Plains Advisory LLC, an investment adviser registered with the State of Nebraska. Insurance products and services are offered and sold separately through John Posey, a licensed insurance agent. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance. Past performance does not guarantee future results. Any information provided is designed to provide general information on the subjects covered, it is not, however, intended to provide specific legal, tax, financial or investing advice and cannot be used to avoid tax penalties or to promote, market, or recommend any plan or arrangement. Material presented is believed to be from reliable sources and no representations are made by our firm as to another parties’ informational accuracy or completeness.  All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation.