Inherited IRA Rules & SECURE Act 2.0 Changes for Spouse and Nonspouse Beneficiaries

One way wealth passes from generation to generation is through inherited IRAs. When it comes to these individual retirement accounts (IRAs), it’s important to understand the rules that have recently changed related to the Setting Every Community Up for Retirement Enhancement (SECURE) Act and its latest incarnation, SECURE 2.0.

Before we begin the inherited IRA discussion, remember that assets in IRAs cannot be left forever. Instead, the IRS requires that money must be withdrawn annually once the IRA owner reaches the required beginning date, or RBD. Before the SECURE Act, the RBD was April 1 of the year following the year the IRA owner turned age 70 1/2. The original SECURE Act that went into effect in 2020 changed the RBD for IRA owners to April 1 of the year the IRA owner turns 72, but only for IRA owners born on or after July 1, 1949. With the passage of SECURE 2.0, the RBD and required minimum distributions (RMDs) moved to age 73 for those who reached that age in 2023.

All types of IRA owners (traditional IRA, SEP, SIMPLE) must withdraw the minimum RMD, except for owners of Roth IRAs. Roth IRAs only have a RMD requirement once the original Roth IRA owner dies and the Roth IRA passes to the beneficiary(ies).

Here’s what else you need to know about inheriting an IRA.

What happens when you inherit an IRA from a spouse?

If you’ve inherited an IRA from your spouse, you have a choice no one else has, and the latest changes to SECURE 2.O did NOT change it. You can add the inherited IRA assets to your own IRA and potentially keep it growing, which may give you more money for retirement. Keep in mind, it has to be the same type of IRA you inherited. For example, if your spouse had a Roth IRA, you have to transfer the money into a new or existing Roth IRA in your own name.

Adding the inherited assets to your own IRA may help preserve any potential tax benefits, including the opportunity for tax-deferred (traditional) or tax-free (Roth) growth. Another reason to consider assuming the IRA is that you may be able to make additional contributions to help build your savings. When you assume IRA assets, you will start taking RMDs based on your age (either 73 as of 2023 or 75 starting in 2033). An advantage of taking RMDs from your own IRA (versus an inherited IRA) is that the RMDs will typically be smaller because of the way RMDs are calculated for IRA owners versus the way RMDs are calculated for beneficiaries.

Once the inherited assets are in your own IRA, if you want tax-free income in retirement or think your tax rate may be higher in the future, you could also consider converting your traditional IRA to a Roth. Keep in mind that, depending on the type of contributions your spouse made to their IRA, you’ll have to pay taxes on the converted amount. Before converting, you might check your spouse’s past tax returns to see if they included Form 8606, which is used to report nondeductible IRA contributions. Nondeductible contributions aren’t taxable when you do a Roth conversion because taxes have already been paid on the money. If neither your inherited traditional IRA savings nor your own personal traditional IRA savings contain any nondeductible contributions, then the full amount you convert to a Roth IRA will generally be taxable in the year you do the conversion.

Additional inherited IRA alternatives for surviving spouses

Here are several other things a surviving spouse could do with an inherited IRA. Remember, the SECURE Act changed “stretch IRA” payments for most nonspouse beneficiaries.

1. Take life expectancy payments from an inherited (beneficiary) IRA. Instead of assuming the IRA, the IRA can be re-registered as an inherited IRA in your name. Whether or not this makes sense for you depends on the type of IRA you have inherited (traditional or Roth), your decedent spouse’s age, and the RMD rules.

As mentioned before, for assets in an inherited IRA, the surviving spouse must take periodic withdrawals, or RMDs. These RMD payments represent a minimum that must be withdrawn by the surviving spouse each year. The payment is calculated based on the life expectancy of the surviving spouse. 

However, typically in an inherited IRA, the surviving spouse who chooses this type of account must use single life expectancy when taking the RMDs. This single life expectancy payment might be much larger than the payment would’ve been had the surviving spouse “assumed the IRA” (as discussed above) and used joint life expectancy once the surviving spouse reached the RMD age. A smaller RMD payment may allow your IRA portfolio to last longer, which is a key benefit for those wanting to avoid running out of money due to longer lifespans. In some cases, it might be beneficial for a surviving spouse beneficiary to use an inherited IRA for a limited time period and then assume the IRA later. Thus, if you’re a surviving spouse beneficiary who wants to limit distributions, be sure to review and compare the amounts that must be taken as well as the timing.

When does the spouse have to begin the RMDs in the inherited account? This starting date depends on whether the decedent spouse had already reached their own RMD age (RBD) before passing away.  

• If the decedent spouse had reached their RMD beginning date (RBD), then the surviving spouse must take any remaining RMDs that the decedent spouse missed in the year of death. The surviving spouse must start taking their own RMD life expectancy payments in the year following the year of death and continue each year. Of course, the spouse can always take more.
• If the decedent spouse had NOT yet reached their RMD beginning date (RBD), then the spouse has two alternatives for starting their life expectancy payments, either: 
1. By December 31 of the year following the year the original account owner died, or (if later)        
2. By the end of the year the original owner would’ve reached their RBD. 

Here are a few more considerations for inherited IRAs based on the type of IRA the surviving spouse inherits:

Traditional beneficiary IRA. Any distributions are generally taxable, but the 10% penalty for early withdrawals before age 59 1/2 doesn’t apply. In addition, the timing of RMDs is based on whether your spouse had already begun taking them at the time of death (to be specific, if your spouse had reached their RBD). If so, you have to continue taking them. If the decedent spouse had not taken their RMD in the year they died, the surviving spouse must take out the RMD for that year too, as discussed above. And remember: There’s also a 10% to 25% penalty for any missed RMDs. 

Roth beneficiary IRA. Although the RMD for inherited Roth IRAs is similar to the RMD rules for inherited traditional IRAs, Roth IRA withdrawals are generally tax free as long as the original Roth IRA was funded for five years or more and any assets withdrawn from converted balances have also been in the account for at least five years. If the spouse beneficiary does not want or need these inherited Roth IRA distributions, they might consider rolling over the inherited assets into their own Roth IRA to avoid these payments as discussed above.

2. Take a lump-sum or random distributionbut don’t run afoul of the 10-year rule. If you have an immediate need for the money, you might decide to receive a lump-sum distribution, although you’d be giving up any tax benefits that you might get by keeping the money in an IRA (like the potential for tax-deferred or tax-free growth). Plus, if it’s a traditional IRA, you may have to pay taxes on the amount you receive, which could possibly push you into a higher tax bracket for that year. If you leave the IRA in your spouse’s name or put it into an inherited IRA, remember you must begin periodic RMD withdrawals unless you qualify for and have elected to take distributions in accordance with the 10-year rule. The 10-year rule requires that all assets in the inherited IRA must be fully withdrawn by the end of the 10th year following the original IRA owner’s death. (If the death occurred in 2019 or earlier, the 10-year rule was a five-year rule.) Generally, spouse beneficiaries may wait until the end of either the 10-year period to make withdrawals, but proposed IRA guidance may require an annual payment for some beneficiaries in 2024 and later. Please consult a tax advisor before the end of this year to determine if you need to make a withdrawal before December 31, 2024, if you’re using the 10-year rule. Remember, you face up to a 25% penalty for failure to make required withdrawals.  

3. Disclaim the inherited assets. You can also refuse all or some of the money. If you do, the inherited assets will pass to the next eligible beneficiary. This could be a way for you to help someone whose financial situation may not be as solid as yours. Before the SECURE Act, it was common to try to stretch out IRA tax benefits to future generations by naming young children, grandchildren, or even great grandchildren as beneficiaries. Under the SECURE Act, big changes were made for nonspouse beneficiaries for all deaths that occurred in 2020 or later. Many must now take all the money out by the end of the 10-year period following the death. Because most of these beneficiaries will no longer be allowed to stretch these payments beyond 10 years, make sure to review your beneficiaries. Note: The decision to disclaim assets generally must be made within nine months of your loved one’s death.

Before moving forward with one of these distribution choices, it’s a good idea to consult with a tax professional who can help you navigate the tax implications. 

Inherited IRAs for nonspouses

The SECURE Act eliminated the “stretch IRA” for most nonspouse beneficiaries. With the stretch IRA, it was possible to use your life expectancy to minimize IRA withdrawals over time. This strategy allowed beneficiaries to shelter a large portion of the inheritance from taxes. The SECURE Act got rid of the stretch provision for many (but spouses can still use it), creating a new 10-year rule. This continues under SECURE 2.0.

For deaths in 2020 or later, only certain nonspouse individual beneficiaries (called “eligible designated beneficiaries”) do not have to deplete the account within 10 years and may use their life expectancy to calculate the minimum amount that must be withdrawn each year. These eligible beneficiaries are:

1. Chronically ill or disabled nonspouse beneficiaries.
2. Nonspouse beneficiaries not more than 10 years younger than the account owner who died.
3. A minor child of the account owner (biological child or legally adopted) but only until that child reaches age 21. Once the beneficiary reaches 21, they have 10 years to deplete the account.

All other nonspouse beneficiaries must use the new 10-year rule to deplete the account. This includes grandchildren and other family members who do not meet the exceptions above. Thus, instead of being able to stretch inherited IRA withdrawals over a lifetime, these noneligible beneficiaries have to draw down the account by the end of the 10th year following the decedent’s passing. 

You can always draw down the account faster as a beneficiary. However, the downside to getting the money faster is that you end up withdrawing larger amounts, which could have a significant impact on your tax bill if the inherited assets were in a traditional IRA, SEP-IRA, or SIMPLE IRA. If the assets were in a Roth IRA, beneficiaries are not taxed on the withdrawal as long as the Roth IRA was funded for five years or more.

Finally, realize that inherited IRAs aren’t exempt from creditors. Although a spouse might be able to avoid having the assets in an inherited IRA taken to settle debts, a nonspouse beneficiary won’t have that luxury. It’s just one thing to keep in mind if you receive an IRA as part of your inheritance.

Inherited IRAs and RMD withdrawal rules

If you inherited a retirement account, generally you must withdraw RMDs from the account to avoid IRS penalties. RMD amounts depend on various factors, such as the beneficiary’s age, relationship to the beneficiary, and the account value. If inherited assets have been transferred into an inherited IRA in your name, this tool may help determine how much you need to withdraw and which distribution method might work best for your unique situation.

If you know that someone plans to leave an inherited IRA to you, make sure you tend to financial matters as soon as possible—even before their death. Family members should keep up on paperwork because incomplete or ambiguous beneficiary forms can cause problems later. In fact, if there’s a discrepancy between a beneficiary form and the will, it’s the beneficiary form that will be heeded—not the will. 

For example, if there aren’t clear beneficiaries, the IRA might just revert to the estate, which often automatically triggers the five-year rule. Under the SECURE Act, nonindividual beneficiaries, like the estate, continue with the five-year rule for mandatory distributions as long as the original account owner had not yet reached RMD age. If the original IRA owner reached RMD age (RBD) and died in 2020 or later, it appears that the estate may take distributions longer than the five-year rule. Under the proposed IRS regulations, the estate must take annual RMDs over the deceased IRA owner’s remaining single life expectancy (reduced by one each year that assets are left in the IRA).

Bottom line

Carefully consider the available choices when deciding what to do with an inherited IRA. Consult with a knowledgeable retirement or tax professional who can take you through the alternatives and help you potentially limit any negative tax consequences. The IRS is close to issuing new final regulations that may affect some beneficiaries, so be sure to review the latest rules with your tax advisor before making decisions. Remember that withdrawing money from a traditional IRA adds to your income, so you’ll be taxed on it at your ordinary income rate. Learn more about inherited IRAs and other accounts here, where we explain the steps to smoothly transition the ownership of the inherited accounts.

TD Ameritrade does not provide tax advice. We suggest you consult with a tax-planning professional with regard to your personal circumstances.