What is an RMD on Inherited IRA?
Retirement planning is a crucial aspect of financial security, and understanding the intricacies of various retirement accounts is essential. One such account is the Inherited IRA, which raises questions about Required Minimum Distributions (RMDs). In this article, we will delve into what an RMD on an inherited IRA is, how it works, and its implications for beneficiaries.
An Inherited IRA is an Individual Retirement Account (IRA) that has been passed down to a beneficiary upon the original account holder’s death. When someone inherits an IRA, they become the new account holder and are responsible for managing the account according to specific rules and regulations. One of these rules is the requirement to take RMDs from the inherited IRA.
A Required Minimum Distribution (RMD) is the minimum amount of money that must be withdrawn from a retirement account each year after the account holder reaches a certain age. For inherited IRAs, the RMD rules are different from those for traditional IRAs and Roth IRAs.
Understanding RMDs on Inherited IRAs
When an individual inherits an IRA, they are subject to RMDs based on their life expectancy. The IRS provides a life expectancy table that determines the RMD amount for each year. Beneficiaries must calculate their RMD by dividing the account balance as of December 31st of the previous year by their life expectancy factor from the table.
For example, if a beneficiary is 55 years old and inherits an IRA with a balance of $100,000, they would need to calculate their RMD using the life expectancy factor for someone at age 55. Let’s say the factor is 29.5 years. The RMD would be $3,397.86 ($100,000 / 29.5).
It’s important to note that the RMD rules for inherited IRAs differ depending on the type of IRA being inherited. For traditional IRAs, the RMDs are taxed as ordinary income, while Roth IRAs have different tax implications.
Calculating and Taking RMDs on Inherited IRAs
Beneficiaries must calculate their RMDs by the end of the year following the year in which the original account holder passed away. For example, if the original account holder died in 2020, the beneficiary must calculate their RMD by December 31st, 2021.
To take the RMD, the beneficiary must withdraw the calculated amount from the inherited IRA by the deadline. If they fail to take the RMD by the deadline, they may be subject to a 50% penalty on the amount not withdrawn.
It’s essential for beneficiaries to keep track of their RMDs and ensure they are taken on time. They can choose to withdraw the RMD from the inherited IRA or from other retirement accounts they may have.
Options for Beneficiaries of Inherited IRAs
Beneficiaries of inherited IRAs have several options for managing the account and RMDs. They can:
1. Take RMDs annually: Beneficiaries can take RMDs each year based on their life expectancy factor.
2. Take RMDs over a fixed term: If the beneficiary is younger than the original account holder, they can take RMDs over a fixed term, such as five years.
3. Take RMDs over the beneficiary’s life expectancy: Beneficiaries can take RMDs based on their own life expectancy, which may result in smaller annual withdrawals.
It’s important for beneficiaries to consult with a financial advisor or tax professional to determine the best approach for managing their inherited IRA and RMDs.
Conclusion
Understanding RMDs on inherited IRAs is crucial for beneficiaries to ensure they comply with IRS regulations and avoid penalties. By calculating their RMDs accurately and taking them on time, beneficiaries can effectively manage their inherited IRAs and make informed decisions about their financial future.
