Inherited IRA $20,000 State Tax Exemption for New York Beneficiaries Under Age 59 ½
For individuals who inherit a retirement account in New York state, there is a little-known tax law that allows an owner of an inherited IRA to distribute up to $20,000 from their inherited IRA EACH YEAR without having to pay New York State income tax on those distributions. While this $20,000 state tax exemption typically only applies to individuals age 59 ½ or older, there is a special rule that allows beneficiaries of retirement accounts to “inherit” the $20,000 tax exemption from the decedent and avoid having to pay state tax on the distributions from their Inherited IRA, even though they themselves are under the age of 59 ½.
Inherited IRA Owners Under Age 59½
If you inherit a retirement account and you are under the age of 59 ½, there is a whole host of rules that you have to follow in regard to the new 10-Year Distribution Rule, required minimum distributions, and beneficiaries grandfathered in under the old “stretch rules.” We have a separate article that covers these topics in detail:
GFG Article on Inherited IRA Rules for Non-spouse Beneficiaries
However, for the purposes of this article, we are just going to focus on the taxation of distributions from inherited IRAs, specifically the tax exemption for residents of New York State.
Universal Tax Rules at the Federal Level
Regardless of what state you live in, there are tax laws at the federal level that apply to all owners of inherited IRA accounts. The two main rules are:
For inherited IRA owners that are under the age of 59 ½, the 10% early withdrawal penalty does not apply to distributions taken from an inherited IRA.
All distributions from inherited IRA accounts are subject to taxation at the federal level.
IRA Taxation Rules Vary State by State
While the federal taxation rules are the same for everyone, the state rules for the taxation of inherited IRAs vary from state to state. In this article, we will be focusing on the inherited IRA tax rules for residents of New York State.
New York State IRA Taxation
New York has a special rule that once an individual reaches age 59 ½ they are allowed to take distributions from pre-tax retirement account sources and not pay NYS Income tax on the first $20,000 each year. This includes distributions from any type of pre-tax IRA, 401(k), private pension plans, or other types of pre-tax employer-sponsored retirement plans.
But……..New York has another special rule that allows a beneficiary of a retirement account to INHERIT the decedent’s $20,000 state income tax exemption and use it when they take distributions from the inherited IRA account, even though the beneficiary may be under the age of 59 ½.
Rule 1: Decedent Must Have Reached Age 59 ½
For the beneficiary to “inherit” the decedent’s $20,000 NYS IRA tax exemption, the decent must have reached age 59 ½ before they passed away. If the decedent passed away prior to age 59 ½, the beneficiaries of the retirement account are not eligible to inherit the $20,000 NYS tax exemption.
Rule 2: The Beneficiary Must Be A Resident of New York
In order to qualify for the $20,000 NYS tax exemption on the distributions from the inherited IRA account, the beneficiary must be a resident of New York State, which makes sense because if the beneficiary was not a resident of New York, they would not be filing a NY tax return.
Rule 3: The $20,000 NYS Exemption with Multiple Beneficiaries
It’s not uncommon for someone to have more than one beneficiary assigned to their retirement accounts. For purposes of the allocation of the NYS $20,000 exemption, the $20,000 annual exemption is split evenly between the beneficiaries of their retirement accounts. For example, if Sue passed away at age 62 and her 2 children Tracy and Mia, both New York Residents, are listed as 50%/50% beneficiaries, once the assets have been moved into the inherited IRAs for Tracy and Mia, they would both be eligible to claim a $10,000 state tax exemption each year for any distributions taken from the Inherited IRA even though Tracy & Mia are both under that age of 59 ½.
Rule 4: What If One of the Beneficiaries Lives Outside of New York?
But what happens if not all of the beneficiaries are New York residents? Does the beneficiary that lives in New York get to keep the full $20,000 New York State tax exemption?
Answer: No. In cases where one beneficiary is a NY resident and there are other beneficiaries that live outside of New York State, the $20,000 New York State tax exemption is still split evenly among the number of beneficiaries even though there is no tax benefit for the beneficiaries that are domiciled outside of New York.
Follow Up Question: Is there any way for the beneficiaries outside of New York to assign their portion of the $20,000 NYS IRA tax exemption to the beneficiary that lives in New York? Answer: No.
Rule 5: Multiple Retirement Accounts with Different Beneficiaries
So what happens if Tim is age 35, and is the 100% beneficiary of his father’s Traditional IRA, but his father also had a 401(k) account with Tim and his 3 siblings listed as beneficiaries? Does Tim get the full $20,000 NYS exemption for distribution from his Inherited IRA that came from the IRA that he was the sole beneficiary of?
Answer: No. Technically, the $20,000 exemption is split evenly among all of the beneficiaries of the decedent’s retirement accounts in aggregate. In the example above, since Tim was one of four beneficiaries on his father’s 401(k), he would be allocated $5,000 (25%) of the $20,000 New York State exemption each year.
Rule 6: How Would You Find Out “IF” There Are Other Beneficiaries?
There are cases where someone will get notified that they are a beneficiary of a retirement account without knowing who the other beneficiaries are on that account. Most custodians will not disclose who the other beneficiaries are, they typically just notify you of the share of the retirement account that you are entitled to. In this case, how do you know how to split up the $20,000 NYS exemption?
Answer: That is an excellent question. I have no idea.
Rule 7: The $20,000 exemption is an ANNUAL Exemption
The $20,000 NYS tax exemption for distributions from inherited IRAs is an ANNUAL exemption, meaning the owners of the inherited IRAs can use this exemption each year. For example, Ryan’s father passed away at age 70, Ryan is only age 45, he was the sole beneficiary of his father’s Traditional IRA account, Ryan would be allowed to distribute $20,000 per year for his Inherited IRA account and he would avoid having to pay New York State income tax on those distributions up to $20,000 each year.
Tax Note: Once the annual distributions exceed $20,000, NYS income tax will apply.
Rule 8: Beneficiary Already Age 59 ½ or Older
If a non-spouse beneficiary is a New York resident and already age 59 ½ or older, do they get to claim both their own $20,000 NYS tax exemption on distributions from their personal pre-tax retirement accounts and then another $20,000 exemption from the inherited accounts?
Answer: No. The $20,000 NYS tax exemption has an aggregate limit for all pre-tax retirement accounts in a given tax year.
Rule 9: State Pensions PLUS $20,000 NYS Exemption
New York also has the favorable rule that if you are receiving a NYS pension, the amount received from the state pension does not count towards the $20,000 annual IRA tax exemption rule. For example, you could have someone who retired from NYS at age 55 is receiving a NYS pension for $40,000 per year, and if they inherited an IRA, they may also be able to exclude the first $20,000 distributed from the IRA from NYS income taxation.
Tax Strategies For Non-Spouse Beneficiaries Subject to 10-Year Rule
Now that many non-spouse beneficiaries are subject to the new Secure Act 10-Year Rule, requiring them to deplete the inherited IRA within 10 years, if the decedent was over the age of 59 ½ when they passed, it’s important to proactively plan the distribution schedule to take full advantage of the $20,000 NYS tax exemption otherwise owners of the inherited IRA could end up paying more taxes to New York State that could have been avoided.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
