#Inherited #IRA #Buy #Home
You can cash out an inherited Individual Retirement Account (IRA) and use it to fund a large purchase like a home without a tax penalty, thanks to rules established by the Setting Every Community Up for Retirement Improvement (SECURE) Act of 2019. The rules relate to non-spousal beneficiaries of IRAs.
Let’s explore how it works.
Key takeaways
- Before the Set Every Community Up for Retirement Enhancement (SECURE) Act, non-spousal beneficiaries of individual retirement accounts (IRAs) could “roll over” their distributions (and their tax benefits) over several generations while the individual retirement account continued to grow tax-free.
- The SECURE Act eliminated IRA rollovers for most beneficiaries, and now the entire account balance must be distributed within 10 years of the original owner’s death.
- There are exceptions for certain eligible beneficiaries, including surviving spouses, minor children of the decedent, beneficiaries who are younger than 10 years of the decedent, and beneficiaries who are disabled or chronically ill.
- While non-spouse beneficiaries can cash out an IRA without paying the 10% early withdrawal penalty, doing so could result in a large tax bill.
Required Minimum Distributions from an IRA: Traditional vs. Roth
If you have a Traditional IRA, you must start taking annual required minimum distributions (RMDs) when you reach age 73 (for account holders born between 1951 and 1959) or age 75 (for those born in 1960 or later). . The amount you receive is treated as ordinary income and is subject to income tax at your tax bracket’s rate.
Roth IRAs, on the other hand, have no RMDs during the account owner’s lifetime. So, the account can continue to grow tax-free for your heirs if you don’t need the money.
If you fail to withdraw at least the required minimum amount each year, you may owe the IRS a penalty equal to 25% of the amount your distribution should have been in most cases, although this number can be adjusted downward in some circumstances.
The rules work differently for IRAs you inherit. Before the SECURE Act, most beneficiaries had to take RMDs. But they can reset the arrhythmia clock, so to speak, by using their ages – which are assumed to be much lower than those of the deceased – and life expectancy to calculate the required distribution size. The younger you are, the smaller the RMD. The advantage of this stretch IRA strategy was twofold:
- Smaller distribution, hence less tax bite
- More money is left to grow tax-free within the IRA
However, the SECURE Act eliminated Stretch IRAs for most beneficiaries. Now, inherited IRA balances generally must be exhausted within 10 years.
SECURE Act and Inherited IRAs
The SECURE Act, passed at the end of 2019, is a game-changer. Here’s a basic summary of the rules for inherited IRAs:
- Spousal beneficiaries usually transfer the money to their own IRA, although they have other options, such as a lump sum distribution.
- A minor child of the decedent, a person 10 years younger than the decedent, or a chronically ill or disabled person can open an inherited IRA and take distributions over time, take a lump sum distribution, or surrender the account.
- A non-spouse beneficiary who does not fall into one of the special categories (for example, a minor child of the decedent) can open an inherited IRA and take distributions within 10 years, take a lump sum distribution, or surrender the account.
Once a minor child reaches the age of majority, the 10-year clock begins to distribute the IRA assets as a beneficiary.
Therefore, non-spouse beneficiaries who inherit an IRA after December 31, 2019, must withdraw all funds from it by the end of the 10th calendar year after the original account holder’s death — and there are no longer distributions based on their life expectancy. (The old rules covered beneficiaries who had already inherited IRAs.)
Stretch IRAs are still allowed for surviving spouses and certain non-spousal beneficiaries, including minor children, disabled or chronically ill beneficiaries, or those who are no more than 10 years older than the original account holder.
The 10-year rule applies whether the participant dies before, on, or after the Required Start Date (RBD) — the age at which RMDs would have begun. However, the SECURE Act does not specify any kind of timeline. You can spread the distributions out over the decade or withdraw everything in a lump sum in one year. However, doing so from a traditional IRA could result in a hefty tax bill and even put you in a higher tax bracket.
Inherited IRAs and Home Purchases
This leads us to purchasing this home. Since you have to withdraw the money anyway, doing so to purchase a property may not be the worst idea, especially if it means you can make a larger down payment or maybe even buy the place outright.
Keep in mind that you may owe income taxes on the amount you withdraw, and if it’s large, that could push you into a higher tax bracket. However, the amount you receive as a distribution will never be subject to any early withdrawal penalties, as would be the case if you were under age 59½ and withdrew it from your IRA. It’s true that first-time homebuyers are exempt from the 10% penalty — but you can only use $10,000 from your IRA for that.
Of course, you may not have to worry about paying a fine or… Taxes If you inherit a Roth IRA, which receives the same favorable tax treatment as the original account. As long as the Roth was opened at least five years ago, your withdrawals will be free of taxes and penalties — even if you withdraw everything at once.
What is an Eligible Designated Beneficiary (EDB)?
The Setting Every Community Up for Retirement Enhancement (SECURE) Act prohibits most Individual Retirement Account (IRA) beneficiaries from rolling over distributions over their lifetime. However, the law creates a group of beneficiaries called eligible designated beneficiaries (EDBs). The EDB is exempt from the 10-year distribution rule and is still allowed to extend distributions over the expected lifespan. You are eligible for EDB if you inherited an IRA from your spouse, are a minor child of the original account owner, are less than 10 years younger than the original account owner, or are disabled or chronically ill.
When do required minimum distributions (RMDs) start?
The SECURE Act (and SECURE 2.0) raised the age at which required minimum distributions (RMDs) begin. You must start taking RMDs when you reach age 73, for individuals born between 1951 and 1959, and age 75 for those born in 1960 or later. Before the SECURE Act, age was 70½, and if you reached that age before January 1, 2020, you had to start taking RMDs after that.
How is an Individual Retirement Account (IRA) taxed?
Bottom line
Depending on your situation, it may make sense to cash out an inherited IRA to fund a large purchase. However, make sure you understand the tax consequences before making any decisions, keeping in mind that you will also lose up to 10 years of potential tax-free growth in the account. It may be helpful to consult a financial planner or tax advisor who can explain your options and help you choose the best path forward.
#Inherited #IRA #Buy #Home
