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Inheriting a Retirement Plan

10/26/2021

Kort Redick, CPA & Leanne Tarleton

The 2019 Secure Act changed the rules of inheriting a 401(k) or IRA if the original owner passed away after December 31, 2019. Most non-spousal beneficiaries who inherit a 401(k) or individual retirement account can no longer take distributions across their lifetime. Unless the non-spousal recipient meets an exception, the recipient must deplete the account within ten years. 

When spouses inherit a retirement account:
Recipients who inherit a retirement account from their deceased spouse have the most flexibility. If the spouse inherits a 401(k) or an IRA, they have the option to take the account as if it were their own individual retirement account. If they decide to take the account as their own, they will need to follow the standard RMD (required minimum distribution) rules. Spousal recipients also have the option to move the money into an inherited IRA. In this case, RMDs would begin when the deceased spouse would have reached the age of 72. Spousal recipients are not required to deplete the account in ten years; they can take distributions across their lifetime.
 
Exceptions to the ten year depletion rule:
Rules for Minors: If the recipient is a minor, the ten year depletion rule will begin once the recipient reaches the age of majority. While the recipient is still under 18 years of age, they must take the annual required minimum distribution.
 
Health and Age: The ten year depletion rule does not apply to the recipient of a 401(k) or IRA if they are less than ten years younger than the deceased. The ten year depletion rule also does not apply if the recipient is chronically ill or disabled. These recipients will be able to take distributions over their lifetime.
 
How to meet the ten year depletion requirement:
The 2019 Secure Act did not create a set amount that recipients must take each year from the inherited 401(k) or IRA.

It is important to consider what type of account the inherited account is. Roth accounts are typically tax-free while traditional IRAs are taxed upon withdrawal. However, the recipient will be taxed on earnings withdrawn if the Roth account has been open for less than five years. The contributed after-tax amounts are still tax-free for Roth accounts that have been open less than five years.
 
If an individual inherits a Roth account that has been open for over five years, they will not pay taxes on distributions regardless of when they take them. Because of this, it can be beneficial to leave the money in the account until year ten, so the money can continue to grow tax-free.
 
If an individual inherits a traditional IRA or a 401(k), they will be taxed on the distributions as ordinary income. Each distribution is taxed at the individual's current income tax rate. It is important to evaluate how this additional income could affect overall taxes. Taking a large distribution in one year could push an individual into a higher tax bracket costing them more in taxes. With a traditional IRA or 401(k), it is typically best to spread the distributions out across the ten years.

Any remaining assets in the account after ten years are subject to a 50% penalty.

It is recommended that beneficiaries of an inherited 401(k) or IRA meet with their IRA custodian, financial advisor, or CPA to discuss their options.