Successor beneficiary of an inherited IRA - what are the distribution rules?

[TerraID]

My wife's mother passed away in 2018 (before the SECURE act was passed) at age 87 and left an IRA to her five daughters in equal shares. My wife has been taking RMD's on her inherited IRA based on (I believe) the life expectancy of the oldest daughter.

Sadly, my wife passed away a few months ago. As sole beneficiary on this account, the inherited IRA has been rolled over into a [Successor beneficiary] inherited IRA in my name. Since my wife passed away after the SECURE act was passed, it's my understanding that I must now withdraw the balance of the funds in this IRA using the Ten Year Rule rather than continuing the life-expectancy RMDs. Note that my wife was 64 at the time of her death, and I am 64.

Questions:

1) Is this correct that I need to use the ten-year rule?

2) If so, does the ten-year clock start in 2019 (year after the original IRA Owner -- my mother-in-law -- died) or 2023, the year after the original beneficiary (my wife) died?

3) With the ten-year rule in effect, are there still annual RMDs required? If so, whose life span is used to calculate these?

Thank you for your help!

[dmertz · Accepted solution]

1)  Correct, you are subject to the 10-year rule.

2)  You must fully drain the IRA by then end of 2032 (based on your wife's year of death, 2022).

3)  Because your wife's mother died after her required beginning date for RMDs, under the proposed regulations you are subject to annual RMDs by continuing your wife's distribution schedule.

You must take your wife's 2022 beneficiary RMD if she had not already done so.  Note that the RMD factor for 2022 must be refigured due to the updating of the Single Life Expectancy table for 2022 and beyond.  This means that the 2022 factor generally will not be the 2021 factor minus 1.  The factor for 2022 will be the new factor for 2019 reduced by 3.

Also, using the age of the oldest beneficiary was only required if the original IRA was not split into a separate inherited IRA for each beneficiary by the end of 2020 or if the beneficiary of your wife's mother's IRA was her estate or was a trust that was not qualified for look-through, otherwise the RMDs would be based on your wife's age, not the oldest beneficiary's age.  Still, with the account required to be drained by the end of 2032 and tax rates scheduled to increase in 2026, it might make sense to distribute more than the RMD each year so as not to have a large spike in income in 2032, perhaps pushing even more of it into years 2022 through 2025 than you would with equal distributions over 10 years.  Also consider that you're still be able to file jointly for 2022, so it might make sense to take out even a bit more in 2022 to take advantage of MFJ tax rates.

[NCperson]

@TerraID sorry for your loss. 

Please read that very last sentence from @dmertz closely.  While you will file married-joint in 2022, you will be filing Single in 2023.  Look closely at the tax rates filing Single.  You ability to withdraw the money from the IRA at a lower tax rate may become more difficult filing Single, which is why @dmertz suggested distributing more in 2022.  IT really depends on your financial situation both in 2022 and 2023.  It is a big financial issue for many once the 1st spouse passes.  

[TerraID]

Thank you for your quick and clear answer--I really appreciate your response. I do plan to withdraw quite a bit of the inherited IRA this year for the reason you mention, as well as converting a chunk of my traditional IRA into my Roth as well.

[fanfare]

@TerraID 

All else being equal,

when you are subject to the 10-year liquidation rule for newly inherited IRAs,
to spread the tax impact most evenly over the ten years,
your divisor should be :   10 - N where N is the number of years gone by.

In other words, with four years gone by, you want to take out one sixth of the IRA,
This rule would generate much larger RMD than the RMD based on Pub590B formulas.

This rule works even if your IRA continues to grow, which it should over ten years.

[TerraID]

Thank you for your reply, but it conflicts with the first response. Dmertz wrote that the ten-year rule is based on my wife's year of death, not her mother's (the original owner). You are saying the opposite; that the 10-year period begins when her mother died. That four years difference is pretty significant when developing a plan to withdraw these funds.

I think it's confusing because my mother-in-law died before the SECURE act was passed, so life expectancy tables were used. My wife as beneficiary died after the SECURE act was passed, so now the ten-year rule applies. Are you sure of your answer?

[NCperson]

@TerraID - I read @fanfare 's response as CONSISTENT with @dmertz .

All that was suggested is that FOR EXAMPLE, in Year 1, at least distribute 1/10 of the IRA balance ...in Year 2, take out at least 1/9 of the then IRA balance....in year 4, take out at least 1/6 of the then IRA balance, etc.  That way you don't get left with a very large distribution (and probably a higher tax bracket) in Year 10. 

I don't see that there was a suggestion that THIS year is YEAR 4 - because of the year death of your MIL.  Using Year 4 in the example was just a conincidence to the numbers of years since your MIL's passing.   

[dmertz]

I agree with NCPerson that fanfare's example should be interpreted as a hypothetical and not intended to suggest that 2022 is year 4 (because it's not).

[TerraID]

Got it--thanks for the clarification!

Note that I explained the above scenario to an IRA specialist at Fidelity today, and he said that the 10-year rule is based on the original owner's year of death (i.e. 2018), not my wife's. I'm not sure whose advice I should take, but just to be safe I'm going to withdraw the funds by the end of 2028. I plan to withdraw ~1/3 of it this year and do a fairly large standard to Roth IRA conversion as well since I can file MFJ, and take relatively equal distributions of the inherited IRA (~1/6 of remaining balance each year adjusted for earnings). This will work well as my income will go up in 2028 when I collect SS, and again in 2030 when I start RMD's on my other retirement accounts. Thanks to each of you for your guidance!

[fanfare]

I did not select 4 years in my example because your owner died in 2018. That is just a coincidence.

Sorry for any confusion.

If nine anniversary years have gone by you want to take 1/1 part or 100% of the IRA in the tenth anniversary year.

If eight anniversary years have gone by you want to take 1/2 part or 50% of the IRA in the ninth anniversary year.

All this is according to Fanfare's Rule.

@TerraID 

[NCperson]

@TerraID - Fidelity's explanation logically wouldn't make sense.  Let's say MIL passed 9 years ago and beneficiary passed this year.....that logic would mean the new beneficiary would have to distribute the ENTIRE balance in the next year as 9 of the 10 years were already consumed. 

that doesn't make any sense!

(I could site the IRS references that the Fidelity explaination is not supportable if necessary)

your strategy is spot on..... there is otherwise a 'time bomb' awaiting when you are forced to take the RMDs.

one other thing to consider... be mindful of IRMAA, which is an additional medicare premium that is a tax in disguise, that kicks in once you begin Medicare.  It is based on your income from two years prior - hence,l be careful in your planning. 

good explanation here: 

https://thefinancebuff.com/medicare-irmaa-income-brackets.html

[dmertz]

The Fidelity rep is apparently mistakenly applying the SECURE Act requirement as if your wife's mother passed after 2019.  Had the SECURE Act been in effect in 2018 (it did not come into effect until 2020), the Fidelity rep would be correct and you as successor beneficiary would just complete your wife's RMD requirements.

SEC. 401(b)(5) of the SECURE Act states that the beneficiary of a decedent who died before 2020 is treated as an eligible designated beneficiary (EDB).  Therefore your wife is treated as an EDB and Section 401(a)(9)(H)(iii) of the tax code applies:

(iii)Rules upon death of eligible designated beneficiary.—
If an eligible designated beneficiary dies before the portion of the employee’s interest to which this subparagraph applies is entirely distributed, the exception under clause (ii) shall not apply to any beneficiary of such eligible designated beneficiary and the remainder of such portion shall be distributed within 10 years after the death of such eligible designated beneficiary.  [Emphasis added]

[TerraID]

dmertz...Thank you for the code citations! I looked those up and agree completely with your interpretation. That gives me a bit more flexibility on distributions. Thanks also to NCperson for the heads up on IRMAA! That wasn't something on my radar, but is now.

[dmertz]

Good point on IRMAA.  Because of the hard thresholds for IRMAA, it might make sense to alternate years of higher income with years of lower income, carefully targeting income levels just under the top of an IRMAA tier rather than every year being in the middle of an IRMAA tier.  Going $1 over into the next tier can mean something like an additional $1,000 in Medicare Part B and Part D IRMAA two years down the road.  In that scenario, that $1 is effectively subject to a 10,000% marginal tax rate, so it pays to be careful.