Inheriting an Individual Retirement Account (IRA) already comes with a unique set of rules, particularly after the passing of the original owner. However, matters can become even more intricate when a successor beneficiary inherits an already inherited IRA. This scenario introduces further layers of regulations, and understanding them is crucial for avoiding pitfalls and managing inherited assets effectively.

What is a successor beneficiary?

A successor beneficiary is, in essence, the beneficiary of a beneficiary. They come into play when the initial beneficiary of an IRA passes away before fully distributing the inherited account and has designated someone to receive the remaining assets.

Key considerations and rules for successor beneficiaries

The rules for successor beneficiaries are often based on the actions and circumstances of the original beneficiary and the original IRA owner, rather than the successor beneficiary's relationship to the original beneficiary. The relationship between the successor beneficiary and the original beneficiary is not relevant. Here's a breakdown of the key factors that come into play:

1. The 10-year rule

The SECURE Act made it clear that successor beneficiaries are subject to the 10-year rule. The 10-year rule is a crucial aspect for successor beneficiaries, but its starting point depends on the original beneficiary's status. If the original beneficiary was a designated beneficiary (not an eligible designated beneficiary), the successor must distribute the assets by December 31st of the year containing the 10th anniversary of the original IRA owner's death. If the original IRA beneficiary was an eligible designated beneficiary (EDB), the successor's 10-year period typically starts on the date of the EDB's death. The IRS also considers original beneficiaries of an IRA owner who died before 2020 as EDBs for this purpose.

10-Year Rule Summary: If the original beneficiary of the IRA was subject to the 10-year rule, the successor beneficiary is subject to whatever time is remaining in that original 10-year period to fully deplete the Inherited IRA. The same rules apply for successor beneficiaries that inherit an Inherited Traditional IRA or Inherited Roth IRA.

2. Spouse as successor beneficiary

A spouse inheriting an inherited IRA from their spouse (the original beneficiary) is generally subject to the same rules as other successor beneficiaries. A spouse successor beneficiary is not permitted to treat the IRA as their own (non-inherited) IRA and they are not able to use their own single life expectancy for distributions. The spouse exceptions for Inherited IRAs, that permit the spouse beneficiary to treat the IRA as their own IRA, only apply to the spouse of the original decedent.

3. Eligible designated beneficiaries and the 10-year rule

If the original beneficiary was an EDB stretching distributions over their lifetime and passes away, the successor beneficiary faces a new 10-year distribution period but must continue annual RMDs in years 1-9 based on the original beneficiary's life expectancy.

RMDs for Successor Beneficiaries

After determining whether the successor beneficiary is subject to the 10-year rule, it must also be determined whether the successor beneficiary is required to take annual RMDs from the account each year. This depends on whether the original beneficiary was required to take RMDs. A basic guideline of this rule is that if the original beneficiary of the IRA was required to take annual RMDs, the successor beneficiary of the Inherited IRA is required to continue taking RMDs. Once an owner of an IRA or Inherited IRA has started taking RMDs, they cannot be stopped. Successor beneficiaries generally must continue any required annual RMDs based on the original beneficiary's life expectancy for the remainder of the 10-year period.

Note: if the original beneficiary was subject to RMDs and had not taken the distribution in the year of their passing, the successor beneficiary must first satisfy the original beneficiary’s RMD in the year of their passing.

Example of calculating RMDs for a successor beneficiary

Let's consider a scenario where a successor beneficiary inherits an inherited IRA, and we'll calculate the Required Minimum Distributions (RMDs) they are obligated to take.

Example Scenario

Original IRA owner: John, passed away in 2021 at the age of 70.
Original Beneficiary: His daughter, Sarah, who inherited the IRA. She was 45 at the time of John's death and was a designated beneficiary subject to the 10-year rule.
Successor Beneficiary: Sarah's son, David, inherited the IRA after Sarah passed away in 2024. David was 20 years old at the time of Sarah's death.
IRA Balance (December 31, 2023): $250,000.
IRS Single Life Expectancy Table: (Used for calculating RMDs for non-spouse beneficiaries).

RMD calculation for David

Since the original beneficiary, Sarah, died while subject to the 10-year rule, David, as the successor beneficiary, is bound to the same 10-year depletion period that started with John's death. This means the entire account must be depleted by December 31, 2031 (10 years after John's death in 2021).

However, the calculation gets a bit tricky for RMDs in the years leading up to the 10-year deadline.

Year of Original Beneficiary's Death (2024): David will need to calculate the RMD for the year Sarah passed away. This is generally the RMD amount Sarah would have taken if she were alive, minus any distributions she might have already received that year.
Subsequent Years (2025-2030): The successor beneficiary must continue taking RMDs based on the original beneficiary's remaining life expectancy, but with a special adjustment. The distribution period is determined by using the original beneficiary's (Sarah's) single life expectancy in the year of her death (2024), and then subtracting one for each subsequent year.
Year 10 (2031): The entire remaining balance of the inherited IRA must be distributed by December 31st of this year, which is the 10th anniversary of the original IRA owner's death.

Example step-by-step for RMD calculation for David in 2025 (Year after Sarah's death)

Account Balance: Let's assume the IRA balance as of December 31, 2024, is $240,000.
Original Beneficiary's Life Expectancy Factor: Sarah was 45 when John died in 2021. So, in the year of her death (2024), she would have been 48. Let's assume the IRS Single Life Expectancy Table factor for age 48 is, for example, 38.1.
Distribution Period: David will use Sarah's life expectancy factor from the year of her death (48) but reduced by one for each year that has passed since Sarah's death. So, for 2025 (year after Sarah's death), the distribution period would be 38.1 - 1 = 37.1.
RMD Calculation: Divide the December 31, 2024 account balance by the distribution period: $240,000 ÷ 37.1 = $6,469.00.

Note: The above example is for illustrative purposes only. Actual calculations require reference to the appropriate IRS life expectancy tables (Single Life Table), which can be found in IRS Publication 590-B, and should also be confirmed with a qualified tax advisor, especially given the complexities of successor beneficiaries and the ongoing updates and clarifications to the SECURE Act regulations.

Tax implications

Distributions from inherited traditional IRAs are typically taxed as ordinary income, without the 10% early withdrawal penalty. Distributions from inherited Roth IRAs are generally tax-free if the account meets the five-year holding period. Note that certain beneficiaries and successor beneficiaries of Inherited Roth IRAs may be subject to the 10-year rule, however no RMDs are required during the 10-year period for Inherited Roth IRAs.

Importance of planning

As with all financial accounts, it’s important to carefully consider beneficiary designations and review them to make sure they are current with intended results. Given the complexity of the IRA/Roth IRA beneficiary rules and the RMD rules, it is crucial to clearly designate beneficiaries, understand distribution obligations, and seek guidance from a financial advisor.

Successor Beneficiaries: Navigating the Complexities of Inherited IRAs