How Inheriting an IRA Works
Inheriting an IRA begins when the original account owner has passed away and has named you as a designated beneficiary. If you’re inheriting a traditional IRA, it’s likely that it was the deceased’s retirement fund. It’s also possible the inherited IRA is a Roth IRA. This means the monetary contributions put into the account were done so after taxes were taken out. Meaning, the deceased would have been able to withdraw funds after the age of 59½ tax and penalty-free if they’ve had the account for five years or more.
There are many inherited IRA rules — from withdrawing funds and filing taxes to naming the account. To make sure your inheritance is properly setup and managed, read on to learn more about the rules of an inherited IRA before consulting with a professional.
Properly Name Your Account
For tax purposes, it’s important to include both the inheritor’s name and the deceased’s name, along with indicating that the account is either a ‘beneficiary IRA’ or ‘inherited IRA’ in the account name.
It would look something like: [Inheritor’s name] Beneficiary IRA [Deceased’s Name]
Spouses Have the Most Flexibility
If you are the spouse of the account owner, you can manage the IRA as your own by rolling over the funds into your own IRA you currently have or by putting it in your name, if it’s within 60 days of the account owner’s death. The rules around withdrawing funds and managing your account in this case would follow the same as if you were the original account holder.
For non-spouse beneficiaries, a separate Inherited IRA is needed, and you must follow additional rules.
Know How You Can Manage Funds
If you’re a non-spouse beneficiary, such as if you inherited an IRA from a parent, you’ll need to withdraw the money sitting in the inherited IRA account at some point. With an Inherited IRA account, you’re unable to contribute to the sitting funds.
Required Minimum Distributions (RMDs) need to be withdrawn starting at age 73 (up from age 72 prior to 2023).
Regardless of whether the original account owner had to begin RMDs, the beneficiary must withdraw all inherited funds within 10 years. The funds will then be subjected to income tax on the amount withdrawn each year but will not incur the 10% penalty if they’re under the age of 59½ . There are several exceptions to the 10-year rule, including:
- If you’re a surviving spouse
- If you’re disabled or chronically ill
- If you’re under 18
- If you’re 10 years younger or less than the IRA account owner
These individuals are exceptions to the 10-year inherited IRA rule, but they must take out the RMD if the account owner is over the age of 73 and hasn’t done so yet for the year, and in the amount the account owner would take.
What to Do with an Inherited IRA
Deciding what to do with your inheritance and when to withdraw funds depends on your situation and strategy. Below are several options to consider when withdrawing your funds, plus the tax implications.
Take a Lump Sum
One option when inheriting an IRA is to strategize how you want to distribute the funds over the 10-year period. You can take one lump sum or take several smaller lump sums over the 10 years. Remember that this would be subjected to income taxes once withdrawn.
Turn it Down
One of your options when inheriting an IRA is to decline. You can do so within nine months of the account owner’s death (unless under 18) and can do so by sending a statement to the IRA administration disclaiming your rights to the IRA.
Open an Inherited IRA in Your Name
As mentioned earlier, you can open an Inherited IRA in your name. To maximize the funds, you can grow the account by waiting until the end of the 10-year timeframe, although this would put your funds in a higher tax bracket once withdrawn.
Choose to Delay Distributions
If you inherited an IRA from your spouse, you could delay the RMDs until you reach the age of 73. If you inherited an IRA from a parent, you’re subjected to withdraw the funds within 10 years, but you can delay until the final year to maximize the account growth.
Who Can I Ask for Help?
The rules around inheriting an IRA are very complex. When it comes to paperwork and taxes on an inherited IRA, the IRS does not offer redos. Filing a wrong form could lead to a hefty fine. Remember that these are just a few of the rules and options around an inherited IRA and it’s best to consult with a trusted tax professional and financial advisor to ensure your funds are properly managed.