How do I avoid the 10-year rule for an inherited IRA?

In recent years, the distribution rules have changed for non-spouses who inherit retirement accounts. Previously, non-spouses could start taking distributions the year after the decedent passed, but could take them over their life expectancy. This offered potential tax benefits as they could spread the distributions over a longer period resulting in smaller distributions. However, the rules in 2020 and beyond now indicate that non-spouse IRA inheritors must distribute the accounts entirely within 10 years.

Avoiding the 10-Year Rule

Generally, you cannot avoid the 10-year rule but some exceptions may apply to you or a loved one. Some designated beneficiaries are exempt from the 10-year rule by falling into one of the following categories:

• A surviving spouse
• A child of the deceased of the account holder who hasn’t reached the age of majority (age 21)
• A disabled or chronically ill person
• A person who isn’t more than 10 years younger than the account holder

Surviving Spouse

A surviving spouse continues to have the option of treating the IRA as their own by rolling/transferring the account into an IRA in their name. This results in delayed distributions until they reach their RMD age and spreading the distributions over their life expectancy. If the spouse needs to take distributions before age 59 ½ for living expenses, they would be subject to the 10% penalty just as they would in their own IRA.

Therefore, if a spouse needed access to the funds before age 59 1/2, they may want to consider remaining a beneficiary and open a beneficiary IRA. In that case, the RMDs would be based on the original owner’s age and not the 10-year rule. Further, it would allow them to avoid the penalty for taking distributions before age 59 ½.

Minor Children of the IRA Owner

There is a special rule for the minor children of the decedent that allows them to take required minimum distributions based on their life expectancy until age 21. Once they reach age 21, the 10-year rule is triggered. Therefore, they must empty the inherited IRA by the end of the 10^th year after reaching age 21. Please note that they must continue to take annual RMDs during that period as well.

Disabled or Chronically Ill Beneficiary

If a beneficiary meets the IRS definition of chronic illness or disability, they can take distributions based on their life expectancy.  The definition generally includes the inability to perform basic functions of daily life, the inability to work, and cognitive impairment.

Beneficiaries Close in Age

This definition seems to be seldom known by most when inheriting retirement accounts. The rule states that if a beneficiary is 10 years (or less) younger than the decedent, the beneficiary can take the RMDs based on their life expectancy. This may include inheriting money from a sibling, cousin, boyfriend/girlfriend, or even a friend.

With any inheritance, we recommend reaching out to a trusted financial advisor to help direct you in making decisions. Some of the decisions can have lasting consequences that could have been avoided or structured a little differently to preserve the inheritance and/or pay less tax!

Have questions? Feel free to contact us.