Inherited IRAs: Big headache, or big opportunity? 

September 13, 2022

If you’re bewildered by something you’ve read recently about the IRS’s distribution rules for inherited IRAs, you’re not alone.

What’s the back story?

Until the law changed a few years ago, an individual who was named as the beneficiary of a parent’s IRA, for example, could count on a relatively straightforward and tax-savvy method of withdrawals called the “stretch IRA.” With the passage of the SECURE Act, that changed for many individuals who inherited an IRA after December 31, 2019. Instead of taking distributions over their lifetimes, affected individuals would need to withdraw the entire inherited IRA account within a 10-year period as calculated under the law.

What’s the problem now?

Too bad about the loss of the stretch IRA, but we’ve all had time to adjust to the new IRS rules, right? Wrong. Unfortunately, the IRS rules are, at the moment, clear as mud. Concern escalated when the IRS issued proposed (but not yet final) regulations earlier this year. Advisors and clients are facing an acute discrepancy between what had been understood by practitioners immediately after the SECURE Act was passed, on one hand, and what the IRS has included in the proposed regulations, on the other hand.

Specifically, some non-spouse beneficiaries of an inherited IRA may not be able to wait until the 10-year post-inheritance mark to fully withdraw the funds in a lump sum, but instead, according to the proposed regulations, must begin taking annual distributions immediately following the inheritance and throughout the statutory 10-year period during which all funds must be withdrawn. This is a hard pill to swallow for those who were counting on years of additional tax-free growth and who had hoped to defer an income tax hit until a lower-income year.

The situation is complicated but worth understanding (we like this very clear article) because of the potential headaches the proposed regulation could cause for those who are caught in the gray area.

A charitable giving opportunity?

The current state of confusion presents an opportunity to learn.

First, anytime you are thinking about IRAs, inherited or not, you’ll want to make sure you know about Qualified Charitable Distributions (QCDs). Through QCDs, an individual who is 70½ or older can use a traditional IRA to distribute up to $100,000 ($200,000 for a couple) per year, which happily counts toward satisfying Required Minimum Distributions, to a qualified charity, including certain types of funds at the Community Foundation. The distribution is not reported by the individual as taxable income because it goes straight to charity.

Second, for those owning inherited IRAs who are caught in the confusion of SECURE Act proposed regulations, a QCD could come in very handy. The IRS does permit taxpayers to make QCDs from inherited IRAs, not just their own IRAs. This option could be a welcome relief to those who are facing the more stringent proposed IRS regulations governing the payout requirements for inherited IRAs.

Please contact us if you have questions about how you can use your IRA to support your favorite charitable causes. We’d be glad to help