Post-Mortem IRA Withdrawal Strategies

Question:        I am the beneficiary of my uncle’s IRA who died at age 65. What is the best way for me to withdraw money from the account?

Answer:          As you might suspect, the strategies for IRA withdrawals differ based on a number of factors and will vary from taxpayer to taxpayer. Among the factors to consider are the current tax rates, prospective future tax rates, and the current and future prospective earnings of the IRA beneficiary. The obvious objective is to withdraw funds in a manner which maximizes the use of a tax deferred IRA but allows for the least amount of tax to be incurred.

The IRA withdrawal requirements for non-spouse beneficiaries depend on whether the IRA owner died before or after his or her “required beginning date”, April 1 of the year following the year in which the decedent attained age 72. Prior to the recent Setting Every Community Up for Retirement Act (the “Secure Act”), two primary withdrawal techniques were available. The overwhelming taxpayer-friendly option for IRA beneficiaries was the stretch option, allowing for the withdrawal of IRA funds on an annual basis over the beneficiary’s remaining life expectancy. For those that did not opt for lifetime withdrawals, the IRA beneficiary could withdraw funds as desired so long as the assets in the decedent’s IRA were withdrawn in full by December 31 of the fifth year following the year of the decedent’s death.  The Secure Act eliminated the popular stretch IRA distribution option, except in a few limited circumstances which include situations where the beneficiary is a minor or disabled. Generally, under the Secure Act, non-spouse IRA beneficiaries must take distributions over a ten-year period. Distributions can be made in one lump sum at any time, in installments or any other manner as the IRA beneficiary chooses so long as the full amount of the IRA is withdrawn by December 31 of the tenth year following the year of the IRA owner’s death.

Since there is no one strategy which works for IRA withdrawals, consider a few scenarios. If the beneficiary is a high wage earner paying tax at or near the highest marginal tax bracket, there may be little point in withdrawing funds from the IRA any sooner than the beneficiary is required to do so. In such case, it may be best to wait out the ten-year period or, if sooner, the date when the beneficiary is no longer reporting income which is taxed at high marginal income tax rates. The beneficiary should, however,  also consider current and future prospective tax rates. While one never knows when legislation will be enacted modifying the income tax rates, consideration should be given to the current historically low income tax rates of recent years and the possibility those rates will increase.

As an alternative, consider a retired taxpayer who is nowhere near the highest marginal income tax bracket and who is reporting the same income each year during retirement. This situation is a bit trickier as the taxpayer must weigh the benefit of leaving funds in the IRA and benefiting from the available tax deferred earnings versus withdrawing funds and having them taxed at lower tax brackets. Without running numbers which is a prerequisite for any IRA withdrawal strategy, the taxpayer might be best to commence IRA withdrawals beginning in the early years following the IRA owner’s death and to continue the process through the ten-year withdrawal period.

It is noteworthy that the rules differ for IRA owners who pass after having reached their required beginning date. A ten-year option is available for IRA beneficiaries in these cases although the beneficiary must withdraw funds in annual installments and does not have the choice of withdrawing funds in any fashion desired during the ten-year withdrawal period. The beneficiary of an IRA owner who died after reaching his/her required beginning date may also withdraw funds on an annual basis over the deceased owner’s remaining life expectancy which in some cases can permit annual withdrawals to extend over a period of more than ten years, depending on the decedent’s age at the time of death. The option to accelerate distributions is always available.

The Secure Act eliminated a favorable withdrawal strategy for non-spouse IRA beneficiaries. With some careful thought and planning, you can nevertheless design an optimal solution for maximizing your after-tax income.

The Tax Corner addresses various tax, estate, asset protection, and other business matters. Should you have any questions regarding the subject matter or if you have questions, you want answered, you may contact Bruce at (312) 648-2300 or send an e-mail to bruce.bell@sfbbg.com.

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