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When a client inherits an IRA, navigating the complexities of withdrawals and understanding tax implications becomes crucial. The IRS has waived required minimum distributions (RMDs) for 2024 for beneficiaries of inherited IRAs who fall under the 10-year emptying rule, as noted by retirement expert Ed Slott. This waiver marks the fourth consecutive year for such a measure. However, Slott advises that skipping distributions in 2024 may not be beneficial for everyone, particularly if the inherited IRA is sizable and the beneficiary is a high earner.
Who is exempt from the 10-year rule? Certain "eligible designated beneficiaries" are not subject to the 10-year rule. This group includes:
- A surviving spouse
- A disabled or chronically ill beneficiary
- A child of the deceased account owner who has not reached the age of majority
- A person not more than 10 years younger than the account owner
Decision-making for 2024 distributions Beneficiaries should consider several factors to decide whether to take a distribution in 2024 despite the RMD waiver:
- Anticipated income for 2024 and corresponding tax liability
- Comparison of projected income to typical yearly income
- Immediate financial needs
For instance, if beneficiaries are in their peak earning years, as often occurs with adult children who inherit when parents live to their normal life expectancy, the tax impact of withdrawing from a significant IRA can be substantial. Distributing the IRA evenly over the 10 years might minimize larger tax hits from lump-sum withdrawals.
Strategic uses for distributed funds If the inherited funds are not needed for immediate living expenses, beneficiaries have several options to consider that align with broader financial goals:
- Invest in taxable accounts: Beneficiaries could use the funds to purchase investments that fit within their current asset allocation, aiding in portfolio rebalancing.
- Contribute to retirement savings: Options include funding a traditional or Roth IRA (subject to income limits), employing a backdoor Roth strategy, or increasing 401(k) contributions.
- Educational expenses: Funds can be used for immediate educational costs or invested in a 529 plan for future expenses. Notably, Secure 2.0 now permits transferring up to $35,000 from a 529 plan to a Roth IRA for the beneficiary.
- Major purchases: Using the distribution for significant purchases like a car can be financially prudent if it avoids additional debt.
- Charitable donations: Donating to charity can not only fulfill philanthropic goals but also offer tax deductions if the beneficiary itemizes deductions.
- Purchase an annuity: This may be suitable if it aligns with the beneficiary’s retirement planning strategy.
Important considerations It is crucial to note that non-spousal beneficiaries cannot roll over an inherited IRA into their own IRA. Also, despite the 2024 RMD waiver, the beneficiary is still required to deplete the IRA within ten years of the original owner’s death.
Handling smaller inheritances or lower-income beneficiaries For those in lower tax brackets or receiving smaller inherited amounts, it may be advantageous to take distributions over a shorter period than the maximum allowed. This strategy can aid in covering expenses or debts without a significant tax burden. However, beneficiaries who are students should be cautious, as increased income might affect financial aid eligibility.
In summary, the strategy for handling an inherited IRA should be tailored to the beneficiary's individual financial situation and goals. Each year, beneficiaries should reevaluate their circumstances and make informed decisions about the timing and amount of distributions.
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