Receiving an inheritance is complex. In the short term, it can create more financial stress than it relieves. Inherited assets may come at a time when you are grieving and uncertain, but they can also allow you to reconsider your own financial landscape. With good planning, inherited assets help support a new chapter, allowing you to invest in new opportunities, consider your own retirement, or pursue other goals that are meaningful to your family.
Inherited assets often come with complex rules and regulations that can feel overwhelming, and working with trusted professionals helps support informed decisions and avoid costly mistakes. In our previous article, Navigating the Complexity of Inheritance, we outlined some of the initial steps and some of the key professional resources available to support you. In this article, we will be focusing on planning considerations and new rules when inheriting a retirement account or IRA.
The Changing Landscape of Inheriting an IRA
Prior to 2020, inheriting an IRA provided the flexibility to stretch the distributions of the remainder of the beneficiary’s life. However, those rules change with the SECURE Act and beneficiaries of inherited IRAs are now required to fully distribute the account over 10 years. In classic IRS fashion, the initial wording left plenty of gray areas. As we move into 2025 there is now clarity that non-spouse beneficiaries have 10 years to distribute an inherited IRA, and they may be required to take Required Minimum Distributions (RMDs) along the way.
The RMD rules for your own retirement account are relatively straightforward. As the owner of a tax-deferred retirement account, you are required to take RMDs when you reach your early-to-mid-70s. RMDs currently start at age 73, but the IRS is scheduled to raise the RMD age to 75 based on specific birth years. With Roth IRAs, no RMDs are required during your lifetime. Once the original account owner passes away, matters grow more complex.
If you inherit an IRA from your spouse, there are special rules. Spouses are allowed to roll these assets into their own IRA, rather than an inherited IRA, and simply follow the normal RMD rules as if this money was in their name all along.
However, as a non-spouse beneficiary, inheriting an IRA means you only have 10 years to fully distribute the inherited account. If the original owner passed away before their own RMD start date, you do not have to take annual RMDs. Rather, if the original owner was already taking RMDs, then you are required to take a minimum distribution each year for years 1 through 9. In either scenario, the remainder of the account must be distributed by year 10. Understanding these distribution requirements and how the income and tax liability fit into your overall landscape creates the perfect opportunity to update your long-term financial plan.
Personalizing Your Distribution Plan
We work with our clients to create an intentional distribution plan for inherited IRAs that seeks to minimize taxes. For some clients, this means taking equal distributions over the entire 10-year period. This approach is often the simplest, and it allows the additional income to be spread out evenly and the taxes to be smoothed out over the entire period. For other clients, this influx of new assets may allow them to think about their own retirement in new ways.
Considering your retirement and Social Security timeline in concert with a distribution strategy can help decrease the total tax liability over the ten-year period. For example, a client may elect to delay any distributions beyond the RMDs until their own retirement, then shift to be more aggressive with distributions once their income decreases. Alternately, layering IRA distributions on top of Social Security has the potential to make the Social Security payments taxable or push you into a higher tax bracket. In some cases, it makes sense to delay Social Security payments while being more aggressive with IRA distributions earlier in the 10-year window.
If there is an immediate need for inherited funds such as deferred home maintenance, funding your child’s education, or a health emergency, this will take precedence over any tactical tax planning. Often, tax mitigation strategies can be woven into any spending plan or personal goals. The bottom line is that there is no ‘one-size-fits-all’ approach, and a good distribution plan needs to consider your liquidity needs, your personal tax landscape, and your other income sources.
Navigating the Complexity
Inheriting an IRA can offer financial opportunities, but it also requires careful planning and understanding of the complexities involved. For most people, the era of stretching distributions over their lifetime is no longer. Beneficiaries must navigate various distribution rules, tax implications, and strategic options to optimize their inheritance. Whether opting for a lump-sum or crafting a ten-year distribution plan based on your income, these decisions have a significant impact on the long-term value of an inheritance.
At North Berkeley, we partner with our clients and their tax professionals to help build plans that recognize the gravity of inheriting new assets, minimize potential tax burdens, and support financial security.
