The Ten Year Rule – The Truth About Inherited Roth IRAs
Craig Wear, CFP® explains the SECURE Act’s change to inherited IRA rules (effective 2020) and clarifies that there are three distinct "10-year rule" scenarios affecting designated beneficiaries, eligible (non-designated) beneficiaries, and successor beneficiaries. He outlines when annual RMDs are required versus when distributions may be deferred until the 10th year, emphasizes knowing the decedent’s age and RMD status at death, and recommends Roth conversions and integrated tax planning to reduce heirs’ future tax burdens.
Chapters
Hey, welcome back. Tax stuff can be really confusing. I mean, there's five year rules, there's holding periods, there's 10 year rules, there's all kinds of things and then there's subcategories and there's exceptions and holy smokes, how do you keep up with it all? So today I want to talk about, try to give you in just simple English, explain to you that, you know, you've heard of this 10 year rule if you have an inherited IRA. There's actually three different 10 year rules and they're pretty important distinctions to be made. And I don't really read a lot about this, I don't hear a lot about it. In fact, sometimes I even forget about it because it's not real common. But if it impacts you and if you have an inherited ira, this is going to impact you in one regard, one way or the other. So I want to try to make it just kind of bottom line, simple English, not make a big deal out of it. Help you to understand how this has an impact in your life and what you need to really be aware of. So let me back up just real quickly. Secure Act 1.0 changed everything in Inherited IRAs. If you received in the Inherited IRA before 29th, before 2020, your distributions were for the most part they were going to be lifetime required minimum distributions. Whether it was, whether it was because of the life of the age of the account holder or your age or combined, it could get convoluted depending on some of those things. But, but they changed all that back in 2019. So that beginning 2020, if you inherited IRA, you have a 10 year distribution requirement and there are four exceptions to that that we won't get into today. One of the other videos I did Talking about inherited IRAs probably will give you a lot of that information and you can look that up. That's pretty simple. But unless you meet one of those exceptions, you have to distribute the account within 10 years and that's where it becomes a oh, but type of moment. Okay, so let me, let me start with this. The one piece of information that you need to know to go down this rabbit hole is you need to know how old was the account owner when they died and had they already started taking required minimum distribution. So required beginning date, which is the age at which someone's required to start distributions right now, is 72 or 73 years old for most people now. And you have to take your first required minimum distribution. You can take it by the December 31st, but you can kick the can to the following April in the year after you reach that RMD age. If you wait till April, just know you got to do two that year. Right. So the distribution rules are really different based on this one piece of info. How old was the account holder when they, when they left it to you? Let me try to make it as simple as I possibly can. If the account holder dies before their required beginning date and you are a designated beneficiary, then your distributions are optional for nine years. So you have to be a designated beneficiary. It can't pass you through the will. It can't pass because you're next in line. You have to be that designated beneficiary. If you are, you don't have to do anything for nine years, but you have to distribute all the account by the end of the 10th year. So you can just kind of wait, let it grow, let it grow, let it grow and just take the big hit in year 10. Probably not the best idea. If you came to us, we would probably show you how to do that differently where you'd save some tax and end up with as much or more money. You have to be designated beneficiary. So if you are an eligible beneficiary but not designated, then you can use the same exceptions that are provided to designated beneficiaries. So being an eligible beneficiary is somebody who's just kind of in line, but you weren't actually listed on the beneficiary designation form that the account owner filled out. Now, if you're a spouse, none of this stuff really applies to you because it just goes into your account. So don't worry about that part. So that's the first thing. On the other hand, if the account holder dies before their requirement beginning date, you have to begin annual distributions based on your own age and the account must be fully distributed by the end of year 10. That's big. That's something that I don't hear talked about. It's something that we got to keep reminding our folks internally about. So if, Let me say that again. If the account holder dies and leaves you their IRA after they have started their required beginning date, you must begin annual distributions. You can't just turn off the faucet on the required RMDs and wait till 10 years to do it. You have to begin doing annual distributions based on your own age. And there are tables that the IRS publishes that you can go figure out what the factor is, multiply, and that tells you how much you have to take. If the account holder didn't take their first distribution, know in the year that they died, you have to take it immediately. So just know that so far what we've got is if they die before they reach their required beginning date and you're a designated beneficiary, you don't have to do anything for nine years. If the account holder dies after the required beginning date, then you have to do RMDs based on your age and make sure it's all out within 10 years. If you are an eligible designated beneficiary and you die. So let's say you were a designated beneficiary of an inherited ira. Or even better yet, let's assume that somebody in your, in your family was a designated beneficiary and they die and they leave it to you and you are then the successor beneficiary. Then you have to take annual distributions according to your own life expectancy and again that now these distributions have to be completed. You have to totally empty out the account by the 10th year. After that original eligible designated beneficiary passes. Okay, so that's three different ten year rules. So what do we do with this? What kind of a, what do we need to consider in tax strategy? I think you have to consider how that inherited IRA is going to impact your own retirement and your own taxation. It could turn out to cause quite a tax burden if it's a large account. If it's a small inherited ira, kind of a moot point, it's not that great big of a deal. But if it's a larger account and it's large enough that it's going to grow over the next 10 years to become a significant amount of taxable income, then by the time you have to distribute it, then you really need to put this in context of a bigger tax plan that's part of a bigger comprehensive financial plan so that the second half of your life you're able to really capitalize on all the opportunities available to you and not leave anything sitting at the doorstep of the IRS just because you didn't take some initiative to get it done. Also kind of consider your own heirs. What will it do to them by leaving your large IRA to them? Roth conversion makes a ton of sense. If you have larger IRAs, it makes a ton of sense almost for everybody. No matter what the size of the IRA is. If your accounts are more modest, maybe you don't have to go to as high a tax bracket and as quick a time, but they all still have to be coordinated within a comprehensive game plan. You still need to have some really great idea of what you need to do. Otherwise, what's going to happen is you're going to leave this large IRA to your heirs. And what's going to happen is millions of dollars, lots of money in taxes, let's put it that way, is going to go to the government only because you didn't do something about it ahead of time. And the best thing to do about it is to get it converted from an IRA to a Roth. If you're an IRA millionaire, as I call it, it is 99% probability that you have got significant taxes that you can avoid for you and for your heirs by getting this taken care of and getting it done. And if you do the conversion now, your heirs don't have to worry about these silly inherited IRA rules and the taxes that it's going to cause on them. Now, you've helped take care of that. You've saved yourself a lot of taxes. You're going to help them by saving them a lot of taxes. And as importantly as anything, you're going to keep your estate from being depleted by a bunch of taxes being paid when you could have made sure that it all went to the people and the causes that you really care about. So if you do have a large ira, or if you believe you're going to inherit one, or you're going to leave one to somebody, some strategic planning really, really should be done to help you with that. You know, I did another video called Roth Conversion Strategies for High Income Retirees. You might want to there's probably a button someplace on this page where you can click and you can go through to that. I would suggest that if this is good content and you like it, give me a thumbs up and say, yep, that was good, Craig. And if you really like getting this kind of information on a regular basis, please click the subscribe button so that next time we do another video, which I do these a few times a week, that you'll be up to date and you'll know when all the new stuff's coming out. So thanks for your time and attention. Hope some of this is helpful to you.
