Inherited an IRA? Some Things You Need to Know
By Kimberly Miller, WMCP®, Financial Advisor, Baird
The SECURE Act passed in 2020, and there has been much confusion over the effects it would have on taking distributions from an Inherited IRA. The IRS has finally provided some answers.
The SECURE Act effectively eliminated the Stretch IRA technique, which had allowed beneficiaries to stretch their required minimum distributions (RMDs) from an inherited retirement account over their life expectancy.
Instead, the new law said IRA beneficiaries of owners who died in 2020 or later would have to liquidate those accounts within 10 years of the death of the owner. Surviving spouses, minor children of the IRA owner, disabled beneficiaries and others (referred to as Eligible Designated Beneficiaries) are exempt from these new rules, but most other beneficiaries will now require some additional planning.
In July 2024, the IRS released final regulations regarding inherited retirement accounts. These regulations clarify the "10-year rule" introduced by the SECURE Act in 2020. Key points:
- Some beneficiaries must take distributions during the first nine years after the original owner's death.
- The account must be fully depleted within 10 years.
- If the original owner died after their required minimum distributions began, and the beneficiary is not an Eligible Designated Beneficiary as defined above, annual distributions are required for years 1-9.
- The IRS chose to waive penalties for those who skipped these RMDs between 2021 and 2024. However, those waivers end in 2024.
It's also worth noting that the required minimum distribution amounts are based on the beneficiary's age and the Single Life Expectancy Table published by the IRS. While this calculation is intended to spread the distributions over the beneficiary's life expectancy, the account must still be depleted within 10 years.
As a result, a beneficiary may be able to take smaller distributions over the first nine years, but they will then be left with a significantly larger distribution in the 10th and final year. This increased income could potentially be taxed at a higher rate than necessary.
Strategies to Minimize the Tax Impact of Your RMD
If you do not need the inherited IRA funds and want to reduce the tax burden, consider these options:
1. Qualified Charitable Distributions (QCDs)
By sending the required minimum distribution from your IRA directly to a charity through a QCD, you reduce your taxable income and eliminate the need to claim a deduction for the gift. In 2024, an IRA owner can give up to $105,000 per year directly to charity in this manner. To be considered a Qualified Charitable Distribution, the following conditions must be met:
- You must be age 70 ½ or older as of the date of the distribution.
- The IRA must be a Traditional IRA (including an Inherited IRA) or an inactive SEP or Simple IRA.
- Funds must be distributed directly to a 501(c)(3) charity.
- Only public charities qualify as eligible recipients of a QCD. Gifts to private foundations, donor-advised funds and supporting organizations do not qualify for QCD treatment; however, gifts to designated and field-of-interest funds at a community foundation are eligible.
2. Donor-Advised Funds
Similar to a family foundation but with fewer administrative responsibilities, a donor-advised fund can also accept appreciated stock, but that's not its only tax advantage.
When you make a donation to a donor-advised fund held at a public charity like Akron Community Foundation, you can take the tax deduction now, even if you haven't yet identified the charity that you want to contribute to. You can also bunch your donations during a high-income year to maximize the deduction and then parcel out the gifts to charities over time as the assets inside the fund grow tax-free.
As mentioned, you cannot donate your required minimum distribution directly to a donor-advised fund. However, you can choose to take your RMD as income and then use the funds to establish a donor-advised fund. This has the potential to give you a tax deduction depending on the size of the gift.
This is a great option for beneficiaries under the age of 70 ½.
3. Charitable Remainder Trusts and Charitable Gift Annuities
Charitable remainder trusts and charitable gift annuities offer a strategic solution to income taxes. They are considered split-interest gifts, meaning they split the benefits between the donor and the charity either for a lifetime or for a period of years. They can offer a significant charitable deduction depending on the size of the gift.
You can currently donate up to $53,000 of your required minimum distribution to a charitable remainder trust or charitable gift annuity as a one-time Qualified Charitable Distribution.
This option is a good one for beneficiaries over the age of 70 ½.
Important Considerations:
- As these rules are complex, be sure to consult with your financial advisor and tax professional for personalized advice.
- Evaluate your specific financial situation and charitable goals before implementing these or any other strategies.
- Stay informed about potential future changes in tax laws and regulations affecting inherited IRAs.
For more information about giving with an IRA, contact Laura Lederer. We're always available to answer your questions about philanthropy or to schedule a personal consultation – all at no cost.