What Is an Inherited IRA?
An inherited IRA, also known as a beneficiary IRA, is an account that is created when someone inherits an individual retirement account. Any person, estate or trust can inherit an IRA, but certain rules and restrictions apply.
Understanding Inherited IRAs
Just like a home, car or real estate, individual retirement accounts can be passed on to beneficiaries after you die.
This holds true for all IRAs, including traditional, Roth, rollover, SIMPLE and SEP IRAs.
The Secure Act of 2019 put several new restrictions in place for withdrawing inherited IRA funds and taking required minimum distributions.
Tax rules for an inherited IRA can be complicated. Consider contacting a financial advisor, certified public accountant or lawyer if you need help.
Inherited IRA Rules for Spouses
If you inherit an IRA from your spouse, you can treat the account like it’s your own. You will need to designate yourself as the new account holder.
You can only treat the account as your own if you’re the sole beneficiary of the IRA.
Another option is to roll the IRA into your own existing individual retirement account.
You have 60 days to roll an inherited IRA into your own IRA.
Remember, you will face a 10 percent tax penalty from the Internal Revenue Service if you withdraw funds from a traditional IRA before the age of 59 and a half.
Required minimum distributions, or RMDs, must be taken from traditional IRAs and these distributions are subject to income tax. RMDs begin at age 72.
If the original owner was already receiving RMDs when he or she died, you must continue to collect these distributions — or submit a new schedule based on your own life expectancy.
If the original owner was not receiving RMDs, you must calculate required minimum distributions based on your own life expectancy.
If it’s a Roth IRA, you don’t have to take any withdrawals in your lifetime.
Inherited IRA Rules for Eligible Beneficiaries
Most non-spouse beneficiaries are required to deplete an inherited IRA within 10 years of the account holder’s death.
This is a new rule established by the Secure Act in December 2019. However, there are four exceptions to the 10-year rule.
Most of these eligible beneficiaries can stretch withdrawals over their life expectancy.
- Minor Children
- The 10-year distribution rule does not begin until the minor child reaches the age of maturity — 18 years old in most states. Minor children must be direct descendants of the account holder to apply for this exception — underage grandchildren don’t count.
- Chronically Ill or Disabled
- The 10-year rule doesn’t apply. You can stretch IRA distributions over your lifetime. A chronically ill or disabled beneficiary must provide certification by a licensed health care provider proving that he or she meets the 10-year rule exemption under the Secure Act.
- Individuals No More Than 10 Years Younger Than the Deceased Account Holder
- This may include siblings, friends or business partners of the deceased. The 10-year rule doesn’t apply, and withdrawals can be stretched over your lifetime.
- Beneficiaries Who Inherited Prior to Jan. 1, 2020
- The 10-year rule doesn’t apply because these beneficiaries are grandfathered under the pre-Secure Act IRA rules. Withdrawals can be stretched over your lifetime.
Inherited IRA Rules for Non-Spouses
Unlike a spouse or eligible beneficiary, other beneficiaries cannot treat an inherited IRA as their own and all distributions must be completed within 10 years after the account holder dies.
- Make any additional contributions to the inherited IRA.
- Roll the account into their existing IRA account.
If you are not a spouse or eligible beneficiary, you have two options.
You can transfer your portion of the assets into a new IRA. This account must be set up and formally designated as an inherited IRA.
Or you can withdraw all the money immediately as a single lump sum. To do so, you must open an Inherited IRA in your name first.
If you opt for the lump sum, you won’t face the tax penalty most people incur for withdrawing funds before the age of 59 and a half.
However, you would still owe income tax on any withdrawals or RMDs made from pre-tax IRA accounts.
The tax rule is different for Roth IRAs.
As long as the account has been open for at least five years and the beneficiary is over the age of 59 and a half, Roth IRA withdrawals can be made without taxation. This applies to both spousal and non-spousal beneficiaries.
7 Cited Research Articles
- Internal Revenue Service. (2020, October 13). Retirement Topics – Beneficiary. Retrieved from https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-beneficiary
- Bergman, A. (2020, September 21). Inherited An IRA? Here Are Your Options. Retrieved from https://www.forbes.com/sites/forbesfinancecouncil/2020/09/21/inherited-an-ira-here-are-your-options/?sh=3f97bac4231f
- Barrett, T. (2020, August 3). Who Can Still Do a Stretch IRA after the SECURE Act: Explaining the Exceptions to the Rule. Retrieved from https://www.kiplinger.com/retirement/retirement-plans/iras/601163/who-can-still-do-a-stretch-ira-after-the-secure-act
- Adams, H. (2020, July 23). Inheriting an IRA? Understand Your Options. Retrieved from https://www.schwab.com/resource-center/insights/content/inheriting-ira-understand-your-options
- Slott, E. (2020, February 27). Did the SECURE Act Kill the Stretch IRA? Retrieved from https://www.aarp.org/retirement/planning-for-retirement/info-2020/secure-act-changes-stretch-ira-rules.html
- Internal Revenue Service. (2020, February 20). Publication 590-B (2019), Distributions from Individual Retirement Arrangements (IRAs). Retrieved from https://www.irs.gov/publications/p590b
- Parthemer, M. R. and Klein, S. (n.d.). The SECURE Act Top Ten. Retrieved from https://www.americanbar.org/groups/real_property_trust_estate/publications/probate-property-magazine/2020/may-june/the-secure-act-top-ten/