A Carroll County widow asks about establishing an individual retirement account (IRA), with the plan that her son would inherit it.
We discussed IRAs designated to be inherited by non-spouse beneficiaries several years ago, but a change in the law that establishes rules for such IRAs means that an IRA owner who wants to leave her account to a child or other non-spouse beneficiary should be aware of the revisions.
The law change is effective for IRAs inherited from original owners who were still living as of Dec. 31, 2019.
Before Jan. 1 of this year, an IRA beneficiary could stretch out distributions over years, depending on life expectancy tables for the beneficiary. For example, a 30-year-old beneficiary could take an annual payment from the IRA for up to 53 years, stretching out the tax bite and allowing the IRA to continue to grow over the years.
Under the law change, non-spouse IRA inheritors will be required to withdraw all assets from the account within 10 years after the death of the original owner. That means the IRA may yield more income in a shorter time frame than the inheritor wanted to take out — and pay tax on.
Some exceptions to the 10-year withdrawal requirement were written into the statute change. The requirement does not apply to minor children — although it becomes effective when a minor child becomes an adult. It does not apply to spouses, individuals who are disabled or chronically ill, or individuals less than 10 years younger than the deceased.
Money you put into an IRA or 401(k) retirement account before it is subject to income tax can grow tax-deferred, but will be taxed as ordinary income when you begin withdrawing it. The traditional reason for building your IRA that way is that you will typically have lower income after retirement, so the tax bite will not be as sharp.
Can you still establish an IRA that you fund with after-tax dollars? Yes. After-tax income is income after all federal, state and withholding taxes have been taken out. It is the disposable income that you have available to spend.
Anyone contemplating creating an IRA for someone not a spouse to inherit may want to sit down with the intended beneficiary and talk about money.
Non-spouses who inherit an IRA cannot simply roll the inherited assets into their own IRAs, according to Fidelity Investments website, www.fidelity.com. These inheritors can transfer the assets into a beneficiary distribution account, which has required minimum distributions, or can disclaim and decline to inherit all or part of the assets.
If a spouse inherits the IRA, he or she can begin taking distributions from the account without penalty — even if under age 59 ½ — if the original owner had been taking required minimum distributions from the account. The distributions will continue to be based on what the deceased person’s age would have been, had he lived, rather than on the beneficiary’s age.
Donna Engle is a retired Westminster attorney. Her Legal Matters column, which provides legal information but not legal advice, appears on the second and fourth Sunday each month in Life & Times. Email her at email@example.com.