Inherited IRA Rules Prior to 2020 and Your Options

If you inherited an IRA from a non-spouse before 2020, you had to take a distribution from the IRA within a certain timeframe, typically by the end of the fifth calendar year following the year of the original owner's death.

In many cases, beneficiaries were required to take annual required minimum distributions (RMDs) from the inherited IRA, starting from the year following the original owner's death. This rule applied to most beneficiaries, but there were some exceptions.

Beneficiaries who inherited a traditional IRA from a non-spouse before 2020 typically had to pay income tax on the distributions, regardless of their age or income level.

If the IRA owner passed away before January 1, 2020, an eligible designated beneficiary may use the lifetime distribution rules that were in effect prior to 2020.

An eligible designated beneficiary includes the IRA owner's spouse, minor child, or an individual not more than 10 years younger than the IRA owner, as well as disabled or chronically ill individuals.

These beneficiaries can take distributions based on the IRA owner's life expectancy factor, using the Uniform Lifetime Table.

If you're wondering who can be an IRA beneficiary, the IRS has three categories to consider.

The IRS defines an Eligible Designated Beneficiary, which is typically a spouse or minor child, and they have more time to take distributions from the inherited IRA.

A Designated Beneficiary is anyone who is named as a beneficiary, but they don't fit into the Eligible Designated Beneficiary category.

A Non-Designated Beneficiary, on the other hand, is anyone who inherits the IRA but wasn't specifically named as a beneficiary.

Here's a breakdown of the three categories:

The five-year rule is a crucial consideration for individuals inheriting an IRA. Any individual beneficiary can choose to distribute the inherited IRA assets over five years following the owner's death.

The distribution deadline is the end of the year containing the fifth anniversary of the owner's death. This means you have a five-year window to take distributions from the inherited IRA.

If you're an individual beneficiary, you have the flexibility to choose how you take distributions, but if you're a non-individual beneficiary, such as a trust, you must use the five-year rule if the owner died before taking required minimum distributions (RMDs).

If the IRA owner had an RMD obligation that wasn't satisfied, you must take an RMD for the year of the IRA owner's death.

The date of death of the original IRA owner and the type of beneficiary will determine what distribution method to use. You'll need to consider the 10-year rule, which requires a designated beneficiary to liquidate the account by the end of the 10th year following the year of death of the IRA owner.

Certain eligible designated beneficiaries are exempt from the 10-year rule, including the IRA owner's spouse, minor child, an individual not more than 10 years younger than the IRA owner, disabled individuals, and chronically ill individuals.

For eligible designated beneficiaries, you may use the lifetime distribution rules that were in effect prior to 2020. If you're unsure about taking distributions in accordance with the 10-year rule, consult your tax advisor.

The 5-year rule applies to non-designated beneficiaries, who would generally be subject to this rule if the account owner died before they were required to begin taking RMDs.

Here are the types of beneficiaries who qualify for the 5-year rule:

Non-designated beneficiaries who inherit an IRA after the account owner's RMD age will be subject to an RMD based on the original IRA owner's life expectancy factor.

Before the SECURE Act, beneficiaries of inherited IRAs or qualified plans could take distributions from an IRA over the balance of their expected lifetimes.

This allowed them to stretch distributions from inherited IRAs over a long time, as they were typically younger than the owners of the IRAs.

The beneficiaries could plan for a modest amount of income stretched over the rest of their lives, which wouldn't change their tax planning dramatically.

Some in Congress didn't like this provision because it slowed the U.S. Treasury's receipt of taxes on inherited retirement plan distributions.

The revenue trickled in slowly, earning the moniker "stretch IRA" because it enabled beneficiaries to receive the distributions over a time stretched far longer than the original IRA owner's lifetime.