Your individual retirement account is ostensibly supposed to serve as a nest egg that you draw from during your senior years. However, there may be a significant amount left in the IRA after your passing. To account for this, you name a beneficiary when you establish the account.
A spouse beneficiary can roll it over into their own account or retitle it as an inherited account. If someone other than your spouse is the beneficiary, there is no roll over option.
Traditional vs. Roth IRAs
Before we provide an important additional detail about inherited accounts, we should share some background information. The traditional individual retirement account is funded with pretax earnings. If you have this type of account, you get a tax break on this level.
You have to pay taxes when you take withdrawals, and you are required to do so when you are 72 years of age. When you are 59.5, you can choose to make penalty-free withdrawals.
Why would the pretax contributions be advantageous if you have to pay taxes at some point anyway? The idea is that you will be in a lower tax bracket when you accept distributions, because you will be retired.
As you would imagine, the beneficiary of a traditional account is required to report the income when they file their annual returns.
Roth accounts are funded after taxes have been paid on the income, and this results in some differences in the guidelines going forward. You can take money out of a Roth account at any age without being penalized as long as you are extracting the contributions.
If you want to tap into the earnings, you have to wait until you are 59.5 years old unless you are willing to pay penalties. Distributions are not subject to taxation because the taxes have already been paid, and this applies to beneficiaries as well.
Required Minimum Distributions
Getting back to the rules for inherited IRAs, the SECURE Act that was enacted in 2019 made a significant change. Before this measure was enacted, people would implement the “stretch IRA” strategy.
Beneficiaries would take only the minimum that was required by law, and this amount was calculated based on their life expectancy and the amount of money in the account. Prolonging the process would maximize the tax benefits.
A provision in the SECURE Act put an end to this practice. Beneficiaries of both types of accounts must clear them out within 10 years after acquiring the assets.
Securing a Strong Retirement Act or SECURE Act 2.0
While we are on the subject, there are some further changes that are very likely to be implemented in the near future via the Securing a Strong Retirement Act. This measure takes the SECURE Act a few steps further, so it is often referred to as SECURE Act 2.0.
Fortunately, the changes do not apply to beneficiaries at all, and they are positive for account holders. One of them will increase the numbers of people that can qualify for the Savers Credit, and it will be set at a flat 50 percent for qualified people regardless of their income level.
Employers will be required to enroll their employees into workplace 401(k) plans, and the employees would have the right to opt out. The required minimum distribution age for traditional account holders would gradually go up to 75.
People between 62 and 65 would be able to set aside an extra $10,000 as a catch-up 401(k) contribution. Right now, the figure is $6500 for older workers. Plus, employers would be able to provide 401(k) matches of student loan payments that are made by their employees.
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