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 contact form and we will get back with you soon as we can.
Mr. Nirenstein is licensed to practice before the courts of the State of Connecticut and the United States District Court. He is a member of the Connecticut and Hartford County Bar Associations, and the Estate and Probate, Elder Law, Business Law and Real Estate Sections of the Connecticut Bar Association.
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