Inheriting IRAs in 2024 and Beyond
Spring cheer when reading about RMDs
The rules around inherited IRAs seem designed to confuse. But you need to understand them if you anticipate inheriting an IRA or passing one on to your heirs. As more Americans than ever turn 65 in 2024, this is an issue that many will soon face. In this article, I describe some basics of traditional (non-Roth) IRAs in non-IRS language.
The Basics
In most cases, an IRA holds money that has never been taxed. IRAs can hold the money you saved over the years from paycheck deductions to a 401(k) plan (a “rollover IRA”), or they can be set up as standalone retirement savings accounts. A fundamental truth of IRAs is that taxes are deferred into the future, not avoided altogether. Think of an IRA as a partnership with the government, with the government’s share equal to your tax rate. Your partner will wait patiently for a time, but eventually expects its cut.
How are IRAs Taxed?
Your IRA money is taxed when: (1) you take it from the account, or (2) you die and your heirs take it out. At a certain age (currently 73), you must withdraw and pay taxes on a portion of your IRA balance each year, with the first withdrawal due no later than April 1 of the year following your birthday. This is the so-called “required minimum distribution”, or RMD, and its basic intent is to cause you to drain (and pay taxes on) your IRA balance over your remaining expected lifespan so that the government gets its share of the partnership.
Don’t be intimidated by the term “RMD”, which is an unavoidable term when discussing this topic. It simply means amount of money you have to take out of the IRA each year and include as income on your tax return. You can use an online calculator to determine the actual amount, which changes each year (an example linked at end of this article). Note that just because you take it out, you don’t have to spend it.
You can withdraw money before you are required to. You will owe taxes on the amount withdrawn, and penalties may apply if you make the withdrawal before age 59 1/2.
RMDs are based on lifespan averages, so it is not unusual to die with a sizable IRA balance. When you die, your heirs are subject to different rules. I will cover these from the perspective of someone who has inherited an IRA, though you should be aware of them if you are likely to pass along an IRA, as you may have an opportunity to reduce your heirs’ taxes with your actions.
What Happens When You Inherit an IRA
When you inherit an IRA, you have options, which depend on who you are. Two common heirs are a surviving spouse and an adult daughter or son.
Inheriting as a Surviving Spouse
If you are the deceased IRA owner’s spouse, you can add the IRA to your own IRA, which is an option no one else has. If you do this, the IRA will be treated as if you were the original owner for withdrawal and tax purposes. Alternatively, you can keep the IRA as a standalone inherited IRA, which causes the RMD calculation to change. The rules here are technical, and the option that is best for you as a surviving spouse depends on several things, including:
your age, and the age of your spouse when they died;
your tax situation (for example, your tax bracket, which will likely go up); and
your need for the money in the inherited IRA.
I provide some links to more detail at the end of this article if you are interested in going deeper on this. If that doesn’t sound exciting, a good planner who knows the rules can help you make the right decision.
Inheriting as an Adult Daughter or Son
If you inherit an IRA from someone other than your spouse, you have less flexibility in timing withdrawals and taxes. My focus here assumes you are 21 or older and inheriting an IRA from a parent in 2024. Also, the rules are different if you are (1) chronically ill or disabled, (2) not more than 10 years younger than the deceased, or (3) a minor younger than 21.
Congress changed the law on inherited IRAs in 2020. These changes introduced something commonly referred to as the “10-year rule”, which unfortunately is not as simple as it sounds. In short, the rules, which cover several pages of fine print, dictate the schedule for paying taxes on an inherited IRA (remember, taxes are deferred, but never avoided entirely). When inheriting from a parent, you will be faced with one of of the following scenarios:
Scenario #1: If the parent you inherit the IRA from passed away before the date they were required to take RMDs (they were 70 at death in 2024, for example), then you must withdraw (and pay taxes on) all of the money from the IRA within ten years of the year of death. You determine how much you withdraw each year, so long as you take it all out by year ten (2034 in this case).
Scenario #2: If, on the other hand, your parent passed away on or after the date they were required to take RMDs (they passed away at aged 85 in 2024, for example), you are required to take a minimum distribution each year following the year of death and deplete the account entirely by the tenth year following the year of death.
If that isn’t confusing enough, the IRS has not finished the rules covering Scenario #2 above. As a stop-gap measure, they have paused RMDs that would otherwise be due through 2024 under Scenario #2 while the rule is being finalized (this does not impact the ten-year countdown from the year of death). They expect to have the rules final for 2025, so stay tuned for updates.
And this is the simple version.
A Note About Taxes
You will be taxed on RMDs and other amounts you withdraw at ordinary income tax rates during the year the withdrawals are made. This will add to your other sources of taxable income and be taxed at your marginal tax rate.
In each scenario above, you have some ability to control how much you withdraw each year, so long as you at least withdraw the required minimum amount. Generally speaking, the more you withdraw, the lower your RMDs will likely be in future years. This may lead you to accelerate withdrawals during years you are in a lower tax bracket in order to manage later taxable income when you are in a higher bracket. For example, if you retire before starting social social security and required withdrawals from your own (non-inherited) IRA, you may have a window of lower taxable income (and lower tax rates) during which you can take money from an inherited IRA and pay taxes at a lower rate than what you may face in the future.
As another example, if you face Scenario #1 above, you may not want to wait until year ten to withdraw the entire balance, as that could push your taxable income into a much higher tax bracket (as high as 37% for federal taxes under current law) in the year you are forced to withdraw it all. Rather, you may want to withdraw smaller amounts over the ten-year period in order to keep your total income in lower brackets, even if not required to do so.
As you can see, the optimal approach depends on your tax situation, as well as assumptions about your future income and tax rates. A good planner can help here, but, with a little effort and some basic spreadsheet work, you can make good decisions on your own, if you are so inclined.
The Bottom Line
The world has shifted from traditional pension plans to do-it-yourself retirement savings in tax-deferred accounts like IRAs. What we inherit is following this shift. In contrast to previous generations, who may have had to grapple with what to do with the family home or farm, our thorniest decisions may now involve esoteric concepts like RMDs and future tax rates. A little bit of knowledge and advance planning can help preserve what our families worked to save.