Personal Finance

Inherited IRAs and RMDs: The Hidden Risks for Heirs

John Seetoo

Published: February 4, 2025 12:25 pm

The aftermath of a loved one’s passing is a somber occasion. While a family may still be in mourning, handling the deceased’s affairs can be an emotionally difficult period. Nevertheless, the dating of one’s death certificate sets the clock ticking for his or her heirs, especially with financial assets that may be bequeathed to surviving spouses, children, and/or other relatives. Failure to deal with the necessary steps mandated by the government in the window of time allotted can result in additional tax burdens and penalties. Sadly, the government doesn’t care about personal loss, crystallizing the hard truths underlying Benjamin Franklin’s astute quote:  “Nothing can be said to be certain, except death and taxes.” 

When tangible assets, like real estate, cars, collectibles, bank accounts, or other items are included in the deceased’s estate, the heirs can usually handle them on their own schedule at their own discretion. The parameters for retirement accounts, specifically for IRAs, are a little different. The Internal Revenue Service has specific guidelines for handling inherited IRA accounts, as the tax-deferral benefits are not completely transferable, and the government, if not required by law to continue waiting, inevitably demands its pound of flesh as soon as possible. 

The IRS guidelines concerning inherited IRAs are contingent on a number of factors, which can include:

• Whether the beneficiary is a spouse or not;
• The age of the deceased and when he or she passed;
• The type of retirement account (standard or Roth);
• Eligible designated beneficiary categorization status;

The IRA rules changed several years ago under the SECURE Act of 2019, and the modified SECURE Act 2.0 (SECURE= Setting Every Community Up for Retirement Enhancement). The SECURE Act: 

• Set the revised IRS rules concerning at what age Required Minimum Distributions (RMD) protocols kicked in, which is age 70 ½ for those born prior to July 1, 1949, age 72 for those born from July 1, 1949 to December 31, 1950,  age 73 for those born from 1951-1959, and age 75 for those born 1960 or later. 
• Mandated when Required Beginning Date (RBD) was calculated as to when distributions on inherited accounts were required and what amounts if RMD applied. 
• Fixed the 10-year rule for IRA account distributions and liquidations for those who passed after January 1, 2020, along with the exceptions under those qualifying for eligible designated beneficiary status. 

Under the SECURE Act, inherited IRA accounts have a 10-year window under which the entire account’s holdings must be distributed, and corresponding income taxes paid by the respective beneficiaries. As this liquidation is mandatory, there is no early withdrawal penalty if the beneficiary is under age 59 ½ at the time of each withdrawal.  

The mandatory redemptions must begin by December 31st of the year following the original IRA owner’s death date of record, thus codifying the RBD for that account. If the deceased was of age to trigger RMD, then that RMD amount or greater must be withdrawn by the beneficiary for that year. 

Additionally, while Roth IRAs have no applicable RMD protocol for an original account holder (who already paid taxes upon the Roth conversion), the RMD kicks back in and becomes the liability of the beneficiary IRA account heir. 

Any individual may exercise an option to withdraw inherited IRA funds under the 5-year total withdrawal rule as well. This is usually automatic for non designated beneficiaries. 

If the deceased died prior to RMD age and beneficiary is not an individual (an institution, organization, etc.) and not a trust, then there is an IRS 5 year rule in effect for withdrawals. 

SECURE Act Exceptions

The SECURE Act does list exceptions to its designated beneficiaries, (i.e., anyone named to receive an asset upon the death of the account holder of record) by creating a category of “eligible” designated beneficiaries. Eligible designated beneficiaries have greater flexibility and different tax treatment in this carve-out exception. This list includes:

• A surviving spouse;
• A disabled or chronically ill person (must meet IRS definition)
• Any child not yet a legal adult (defined as the age of majority under state law) – is subject to a 10-year rule once reaching legal adulthood.
• A person less than 10 years younger than the deceased

In the case of a surviving spouse, that person has several options:

• Assume ownership of the deceased’s IRA account 
• Rollover the inherited IRA into a pre-existing one owned by the surviving spouse
• Declare themself an account beneficiary

The standard rules for RMD would transfer in the first 2 cases, with the rollover needing to be completed within 60 days as in any other IRA rollover or combination.  If the surviving spouse decides to be treated as an eligible designated beneficiary:

• If the original owner was already subject to RMD, the spouse can continue distributions based on the deceased’s original life expectancy calculation.
• If the deceased had not yet reached RMD age, the spouse would have the discretion to delay RMDs on the account until the deceased would have reached age 73. 
• The surviving spouse can also opt to submit a new RMD schedule based on the spouse’s own life expectancy.

For the other three eligible designated beneficiary categories, the revised RMD would be based upon each beneficiaries’  respective life expectancy. 

Tax Considerations

There are several strategies and tips that beneficiary families can take to help mitigate taxes that will accrue from inherited IRA accounts.

• Non-spouse beneficiaries will need to establish a new FBO (for benefit of) account that indicates to the IRS that the account was inherited. Otherwise, the IRS will treat the entire lump sum as a distribution and levy income taxes accordingly. 
• If there are multiple beneficiaries, the IRA account can be split up to best organize life expectancies among non-spouse designated beneficiaries and eligible designated beneficiaries, if they are so inclined. These split arrangements would need to be completed before Dec. 31st of the year following the date on the deceased’s death certificate. 
• If the deceased had a large estate that already paid federal taxes, beneficiaries are entitled to prorated tax deductions for their respective allocations of the IRA account’s assessed tax liability. 
• Distributions from inherited IRA’s are considered Form 1099 passive income. Depending on the size of the distribution, it can potentially bump one up to a higher tax bracket. Recipients may wish to consider tax harvesting and other potential deductions that are applicable against passive income to mitigate net taxable income during distribution years.
• Beneficiaries have the option to disclaim all or part of inherited IRA benefits. This may sometimes occur when one of the beneficiaries becomes wealthy and would prefer that designated benefits in their name not be taken for tax reasons or would prefer they be added to the surviving spouse and other beneficiaries. In such instances, the disclaimer must be filed within 9 months of the account owner’s demise and prior to taking possession of any portion of the IRA.

This article is intended solely for informational purposes. A retirement benefits financial professional should be sought for more comprehensive advice.