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Inherited IRA written on piggy bank

Financial Planning > Trusts and Estates > Estate Planning

Should Your Client Tap Their Inherited IRA in 2024?

By Roger Wohlner

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What You Need to Know

  • The IRS' ever-evolving guidance on when RMDs must be taken from these accounts under the Secure Act has created confusion.
  • The tax liability can be substantial in some cases where the beneficiary is subject to the 10-year rule.
  • One option is to withdraw an equal amount for each of the 10 years to avoid a lump-sum distribution.

When a client inherits an IRA, they will have questions about when they should withdraw the money and what they should do with it. The IRS’ ever-evolving guidance on the requirement under the Setting Every Community Up for Retirement Enhancement (Secure) Act that most inherited IRAs be emptied in 10 years has led to confusion.

The IRS recently waived required minimum distributions in 2024 for beneficiaries of inherited IRAs who are subject to the 10-year rule. This is the fourth year in a row that the IRS has done this, retirement expert Ed Slott noted. 

But, as Slott pointed out, just because beneficiaries don’t have to take a distribution this year doesn’t mean they shouldn’t.

Unless the inherited IRA is a Roth IRA, there could be significant tax implications, especially if the inherited IRA is sizable and if the client is a high earner. (Inherited Roth IRA assets must also be withdrawn within 10 years, but there are no taxes on the distributions as long as the money was in the account for at least five years.)

Clients with inherited IRAs will need advice on how to proceed with taking distributions. That advice will likely vary based on their situation.

Who Is Not Subject to the 10-Year Rule?

Beneficiaries who fall under the classification of eligible designated beneficiaries are not subject to the 10-year rule. Eligible designated beneficiaries generally include:

  • A surviving spouse
  • A disabled or chronically ill beneficiary
  • A child of the deceased account owner who has not reached the age of majority
  • A person who was not more than 10 years younger than the account owner

Should Your Client Take a 2024 Distribution?

These questions can help determine whether it makes sense to take an inherited IRA distribution even though RMDs are waived in 2024:

  • What is the client’s anticipated 2024 income and their tax liability?
  • How does their projected 2024 income compare to a normal income year?
  • Do they need the money?

For example, when adult children inherit an IRA, it is often common for them to be in their peak earning years. This may be especially true if the parents reached their normal life expectancy. In this situation, the tax hit can be significant if the IRA is of significant value.

One option is to take an equal amount in withdrawals from the account for each of the 10 years to help avoid a large lump-sum distribution, with a large tax hit, over a one- or two-year period. This can be a good option for clients whose income will be relatively stable over the decade.

If clients’ earnings tend to fluctuate, it will be beneficial to sit down with them each year to assess their income for the current year. Try to match the distributions with years where the income might be on the lower end of their normal range. 

What Can the Beneficiary Do With The Money?

If the funds from an inherited IRA distribution aren’t needed to meet living expenses, there are any number of ways that clients can put the money to use to align with overall financial planning strategies.

Step one is to encourage them to put some of the distribution aside to cover the anticipated tax liability.

Potential uses for some of the rest of the money from the distribution might include:

  • Adding to a taxable investment account. This money could be invested in ways that are consistent with their asset allocation. These new funds could be used as part of the portfolio rebalancing process to add to asset classes that were previously under-allocated to.
  • Contribute to an IRA. Whether that’s a Roth or traditional account will depend on a client’s income and eligibility for these accounts. A backdoor Roth could also be an option.
  • Increase contributions to a retirement account such as a 401(k). If clients aren’t contributing the maximum to their employer-sponsored retirement account, they could use the money from the distribution to offset an increase in the amount they are deferring from their paychecks.
  • Use the money to cover a child’s college expenses. Depending upon the amount of the distribution and the annual cost of their children’s education, some or all of the inherited IRA distribution could be used to cover these expenses for the current year.
  • Fund a 529 plan for a child’s future higher education expenses. As an added bonus here, the Secure 2.0 rules now allow for up to $35,000 to be transferred from a 529 account to a Roth IRA for the 529 account beneficiary. This can be a way to take some of the inherited IRA distributions and use them to fund a Roth IRA for the next generation.
  • Use the distribution to fund a major purchase such as a car. While some may not see this as a good use of the money, if this allows a client to avoid taking out a loan or tapping other resources, this can make sense.
  • Donate some or all of the distribution to charity. For those who are charitably inclined, this is just a good thing to do. Additionally, if the client can itemize deductions, the contribution would provide a tax deduction that could offset some or all of the taxes paid on the IRA distribution.
  • Purchase an annuity if this fits with a client’s overall retirement planning.

Note that non-spousal beneficiaries can’t roll over an inherited IRA into their own IRA account. It’s also important to note that even though the IRS has waived the RMDs on inherited IRAs for 2024, this does not relieve these beneficiaries of the responsibility to have emptied the account within 10 years of the owner’s death.

Other Situations

If the beneficiaries subject to the 10-year rule are in a lower income bracket or the amount of the inherited IRA is relatively low, it may make sense for them to take the distribution all at once or perhaps over a period shorter than the 10-year maximum.

For example, if the beneficiaries are college students, the money may be sufficient to cover a significant portion of their college expenses. One caution here is that the amount of income generated could jeopardize financial aid.

If the beneficiaries are in a lower income situation, taking the distribution over a shorter period can be of help with expenses or paying off debt. While there will be taxes, these may not be a big factor due to their lower income level. 

Roger Wohlner

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