Four categories are recognized under current regulations to qualify as an Eligible Designated Beneficiary (EDB). These include:
- the surviving spouse
- minor children of the decedent
- a disabled or chronically ill individual as assessed at the time of the decedent’s passing
- other individuals who are no more than ten years younger than the deceased account owner
If you fall into one of these categories, you’ll be afforded more time and flexibility than Non-Eligible Designated Beneficiaries. This is due to recent regulatory changes, underscored by The Secure Act, altering the landscape of inherited IRAs.
Rules and Options for Surviving Spouses
Surviving spouses enjoy the widest range of choices for handling inherited accounts. Key among them are the options to roll over the account into their own IRA, keep it as an inherited IRA, or consider varying stances based on the decedent’s Required Minimum Distributions (RMDs). Survivors have distinct strategies to evaluate if the original account owner had not begun their RMDs. By rolling the account into their own, spouses can consolidate assets, although they need to be wary of the 10% penalty on early withdrawals if under 59½. The flexibility of an inherited IRA can be particularly beneficial, especially in terms of RMD calculations and avoiding early withdrawal penalties.
Benefits of Being an Eligible Designated Beneficiary
The benefits of being an Eligible Designated Beneficiary (EDB) are that you really have more time and flexibility when dealing with inherited IRAs. Unlike non-eligible beneficiaries who are limited to a strict ten-year distribution period, EDBs can choose from various withdrawal schedules.
This flexibility allows EDBs to extend the tax-deferred growth of the inherited funds over a longer period, which is a huge advantage in strategic tax planning. By having the option to stretch distributions, EDBs can mitigate the tax impact in any given year and potentially stay in a lower tax bracket.
Common Risks and Pitfalls
There are four common pitfalls that EDBs should beware of:
- Tax Planning Oversight: Failing to consider the disparity between current and future tax rates. Immediate distributions, while in a high tax bracket, might not be as favorable as deferring to lower-income retirement years.
- Premature IRA Rollovers: Automatically rolling an inherited account into your own IRA without considering cash flow needs and the penalties involved in early withdrawals.
- Neglecting RMDs: Overlooking the need to continue RMDs in the year of the account owner’s death can result in steep penalties.
- Forgetting to Update Beneficiaries: If you don’t name a new beneficiary it will complicate the process for your heirs.
Make Informed Decisions
Navigating the complexities as an Eligible Designated Beneficiary can be daunting, and your personal circumstances and lifestyle should inform your choices. Getting support and advice from a financial planner is invaluable in making these decisions, especially during emotionally challenging times such as losing a loved one. Understanding your options, evaluating risks, and actively planning with the future in mind ensures that any inheritances offer opportunities for financial growth and stability.
Outline of This Episode
- [00:00] The complexities and benefits of being an eligible designated beneficiary (EDB) for inheriting an IRA.
- [03:34] Eligible designated beneficiaries have two key advantages: more time and flexibility in inheritance.
- [08:21] Withdrawing from an IRA before age 59 incurs a 10% penalty and income tax; RMDs depend on age, starting at 73 for most people.
- [10:10] The stretch IRA avoids a 10% penalty by basing RMDs on life expectancy.
- [15:46] Timing distributions strategically can reduce tax liability. Wait until retirement to avoid high tax brackets.
- [18:01] Evaluate options carefully when inheriting an IRA, considering tax implications and future changes.
