What is IRS 10 Year Rule

irs 10 year rule

This IRS rule requires the Individual Retirement Account (IRA) beneficiaries to claim the entire balance of the IRA by the end of the year, or on December 31 of the year when the 10th anniversary of the IRA owner falls and when they are not claiming the life expectancy payments.

A beneficiary can be anyone who the IRA owner chooses to receive the IRA after the owner or the participant dies. Usually, the designated beneficiaries are the decedent’s spouse. The beneficiaries need to include any taxable amount they receive in their gross income when filing for a tax return.

According to IRS Publication 590-B, inherited IRAs for surviving spouses can be treated in three different ways. The first one is my designating yourself as the account owner. The second is by rolling it over to your IRA, or the full extent taxable. Lastly, you can treat it as your own.

You will be considered to treat the inherited IRA as your own if there are contributions made to it or if you have not claimed the required minimum distributions for a year as the IRA beneficiary. However, this is only possible if you are the sole beneficiary or you have the unlimited right to withdraw from it.

On the other hand, inherited IRAs from someone else other than your spouse, treating it as your own is not possible. You are not allowed to make contributions to the IRA nor roll it over. You can only make a trustee to trustee transfer while the entire amount being transferred remains in the name of the deceased owner.

Why are there Required Minimum Distributions?

Traditional IRAs cannot be kept forever, distributions are needed to be done. According to RMD rules, in cases that the minimum amount for distribution can’t be met or there are no distributions at all, a 50% excise tax will be paid depending on the amount which is required to be distributed whether the owner died or is still alive. You can calculate required minimum distributions (RMD) depending on which bracket you are in.

The requirements for distribution differ depending on if you are the IRA account owner or the beneficiary. Last 2020, there were no required RMDs. However, for the year 2022, the Internal Revenue Service has required RMDs even for the inherited IRAs. The SECURE act changed a lot of IRA RMD rules including the push back of the onset age from 70 1/2 to 72.

Beginning last January 1, 2021, the SECURE act requires the inherited IRA to be withdrawn by the designated beneficiaries within ten years from the date of the IRA owner’s death and pay the income tax return for the distributions – also known as the 10-year rule. The 10-year rule is applicable regardless of whether the IRA owner dies before, after, or on the beginning date.

What is the Required Beginning Date?

For IRA owners, distributions should be received by April 1st of the year after your 72nd birthday. Once you turn 72, you should be able to start receiving the required minimum distribution. If you don’t receive it on the year you turned 72, you should it receive on April 1st of the following year.

If the owner’s death happened after turning 72 but before the 1st of April, there is no need for minimum distribution because the death didn’t happen before the required beginning date.

What is the Difference between Traditional IRA and Roth IRA?

Young or old, investments and plans for retirement will never be a bad idea. Opening Individual Retirement Accounts (IRA) which are employer-sponsored plans should be one of your retirement arrangements. These accounts allow you to save for your retirement while working and save on taxes too. Different kinds of IRAs come along with different rules and benefits.

Traditional IRA

  1. A Traditional IRA is a pre-tax contribution in which taxes are deferred and immediately gives you tax benefits though there are limitations for participants in employer-sponsored plans. Anyone who has income is eligible for this kind of IRA and has a maximum contribution of $6,000 for 50 years old and below, and $7,000 for 50 years old and above.
  2. It has no penalties during withdrawals but becomes a taxable income after reaching the age of 59 1/2 but requires mandatory distributions upon reaching the age of 72 as mentioned in publication 590 b. It is recommended for those who are expected to be on the same or lower tax bracket when account owners start withdrawing.

Roth IRA

  1. Roth IRAs are after-tax contributions that are tax-free but do not have current-year tax benefits. Like traditional IRAs, its maximum contribution is also at $6,000 for 50 years old and below, and $7,000 for 50 years old and above. However, unlike the traditional ones, it is a penalty and tax-free (even for inherited Roth ira) after 5 years and the account owner ages 59 and a half with no required mandatory contributions.
  2. It is recommended for those who expect to be in a higher tax income bracket when starting to take withdrawals.

As always, do your due diligence and consult a tax profession or risk an IRS audit (which can typically go back 3 years).

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