You may already know that when you reach the age of 70 ½, you’re mandated by the IRS to start taking Required Minimum Distributions (RMDs) from tax-deferred IRAs, 401(k)s and other retirement accounts.
What you might not know is RMDs may come into play for you a whole lot earlier than your 70th birthday if you inherit an IRA or Qualified Retirement Plan (401k, 403b, etc.).
While helping my mom determine her first RMD, I read a few articles discussing what to do if you miss taking the required distribution in a given year. Sometimes those who fail to make a distribution are those who unknowingly inherited funds or those who just didn’t understand the RMD requirement.
So this post is to remind you to speak to your family members about any accounts you or they may be listed as a beneficiary on so you all know what to do with those accounts after the account holder’s death. This post outlines what you need to know about RMDs, specifically inherited retirement account RMDs to help you avoid making potentially costly mistakes.
Disclaimer alert – I’m not a tax or financial professional, and any information described below should not be constituted as professional instruction or advice. Talk with your tax advisor or CPA for more detailed and specific advice.
What Do I Need To Know About RMDs When I Inherit a Retirement Account?
Rules for receiving the inherited money vary depending on the type of the account inherited and the age of the deceased, as well as your relationship with the person who passed.
The age of the person who passed is essential because it is typically the original account owner’s birthdate used to determine when you must start taking withdrawals from the account(s).
You may be a named beneficiary as a spouse, child, friend, extended family member, or as a trustee or executor.
And the types of retirement accounts you may inherit, include:
- Qualified Retirement Plans – 401(k) or 403(b) plans sponsored by an employer or a profit-sharing plan
- IRA’s – Traditional IRA, employer-sponsored SEP-IRA, SIMPLE IRA, or Roth IRA
You’ll want to be aware of all the above because if you fail to take RMDs when you should, you could be facing a 50% tax penalty on the amount you did not take.
Which means if you failed to withdrawal a $10,000 RMD, you might end up paying $5,000 to the IRS as a penalty on top of the regular income tax you may owe, when you do finally take the distribution.
What Are My Options Based on the Information Above?
The IRS doesn’t wish to let investments in IRAs go tax-deferred forever, so they designed RMDs. Thus the rules regarding when beneficiaries of IRAs must take RMDs is in large part based on the account owner’s age at the time of their death.
Note: The required beginning date (RBD) for a retirement account owner is April 1 of the year after they reach age 70 1/2. Account holders need to take their first distribution before the RBD.
RMDs on inherited accounts may be calculated by benefactors (other than qualified trusts) using either of two different methods, the life-expectancy method, and the 5-year method.
- Life-expectancy method – Requires annual withdrawal amounts from the inherited accounts based on IRS life-expectancy formulas. You can always withdraw more than the RMD amount but not less.
- 5-year method – This method is available if the account owner passes before their RBD date. It requires you to withdraw the entire account balance by the end of the fifth year after the year of the original account holder’s death. Withdrawals may be made at any time and in any amount within those five years.
One thing I should also mention but do not cover in detail below is that you may also take lump-sum distributions from inherited accounts in some instances and then you would not be subject to RMDs. Details can be found at the links provided above.
IRA RMD Calculations for Spouses
If you are the only beneficiary of the account, you may transfer the IRA assets to your own Traditional IRA, and future RMDs are calculated starting with your RBD and your life expectancy. You may access the funds anytime, however, should you withdraw money before age 59 1/2 you may face penalties unless you meet specific exception criteria.
Alternatively, you may transfer the funds to an Inherited IRA held in your name and follow the following rules.
If your spouse was 70 1/2 or older, your RMDs must start by December 31 in the year following their death. But, if they did not take RMDs in the year of their death, you are required to take that amount by the end of the year of their passing.
If your spouse was under 70 1/2, you have two options:
You must take RMDs based on your life expectancy by whichever is later:
– December 31 of the year after the year of your spouse’s death, or
– December 31 of the year in which your spouse would’ve turned 70½.
The entire account funds must be withdrawn by the end of the fifth year after the year of your spouse’s death.
IRA RMD Calculations for Other Qualified Beneficiaries
When you inherit a non-spousal IRA you are subject to these guidelines:
If the original account holder was 70 1/2 or older, your RMDs must start by December 31 in the year following their death. But, if they did not take RMDs in the year of their death, you are required to take that amount by the end of the year of their passing.
If the original account holder was under 70 1/2, you have two options:
You are compelled to start RMDs by December 31 of the year after the original owner’s death, based on your own life expectancy rates. Note, if there are additional beneficiaries all should establish their own individual accounts before December 31 of the year after the year of the original account holders passing. If this is not done, the life expectancy of the oldest beneficiary is used for RMD calculations.
The entire account balance must be distributed by the end of the fifth year after the year of the original account owner’s death.
What You Need to Know About RMDs and Roth IRAs
While Roth IRA owners won’t need to bother with RMDs during their lifetimes, their beneficiaries who inherit Roth IRAs must (except spouses who transfer the Roth IRA to their own Roth IRA.).
When you inherit a Roth IRA, you will calculate your RMDs as if the account owner had passed before their required beginning date, regardless of their actual date of passing.
For Spouses who transfer funds to an Inherited Roth IRA
You must begin annual RMDs based on your life expectancy by the later of:
December 31 of the year when your spouse would have reached 70 1/2 or December 31 following the year your spouse died. Or, you may follow the five-year rule and fully distribute all funds by December 31 of the fifth year following your spouse’s death.
For Other Qualified Beneficiaries
You must begin annual RMDs based on your life expectancy by December 31 of the year following the original account owner’s passing, or follow the five-year rule.
Qualified Retirement Plans
As the beneficiary of a Qualified Retirement Plan, you may be allowed to keep the funds within the plan depending on plan rules, so I encourage you to contact the plan administrator.
Additionally, the funds may be taken as a lump sum or transferred to your own Traditional IRA or Inherited IRA depending on your relationship to the account owner. Should you transfer the funds to your own IRA similar guidelines as above apply based on the original account holder’s age at death.
Disclaimer alert again – I’m not a tax or financial professional, and any information described above should not be constituted as professional instruction or advice. Talk with your tax advisor or CPA for specific information and advice.
Remember to speak with your family members and friends about beneficiary designations and share what to do when an account is inherited. In fact, add it to your ‘big book of financial information‘ you may save yourself and them a very costly mistake.
Do you have experience with an inherited retirement plan? Please share your experience or let us know if there is something important I missed.