Inherited IRAs: A Comprehensive Guide

When you inherit an IRA, you’re stepping into a unique financial opportunity—and a responsibility. Whether you are a spouse, child, other individual beneficiary, trust, or estate, the rules governing an inherited IRA can have a significant impact on your taxes and financial planning.

The rules also changed substantially under the SECURE Act for many people who inherit retirement accounts from someone who died after 2019. Understanding your beneficiary status, distribution deadlines, and the tax consequences of withdrawals can help you avoid costly mistakes.

What Is an Inherited IRA?

An inherited IRA is an IRA received by a beneficiary after the original account owner's death. The beneficiary can be a spouse, another individual, a trust, an estate, or another eligible entity, depending on the account's beneficiary designation.

An inherited IRA is different from your own IRA. In most cases, a non-spouse beneficiary cannot simply treat the inherited IRA as their own account or make new contributions to it. Instead, special distribution rules apply based on the beneficiary's relationship to the deceased account owner and other circumstances.

For example, if you inherit a traditional IRA worth $200,000, the way you take distributions can affect both the investment growth of the account and your taxable income over several years.

Types of Inherited IRA Beneficiaries

Spousal Beneficiaries

A surviving spouse generally has more options than other beneficiaries. Depending on the circumstances, a surviving spouse may be able to:

• Treat the inherited IRA as their own IRA.
• Roll the inherited IRA into their own IRA.
• Keep the account as an inherited IRA and take distributions under beneficiary rules.

If a surviving spouse treats the IRA as their own, the account generally becomes subject to the rules that apply to the spouse's own IRA, including the applicable required minimum distribution rules.

Example: Mary inherits her husband's $100,000 traditional IRA at age 65. Depending on her circumstances, she may choose to keep it as an inherited IRA or treat it as her own. The choice can affect when required distributions begin and how future withdrawals are taxed.

Non-Spouse Beneficiaries

Children, siblings, friends, and other individual beneficiaries generally cannot treat an inherited IRA as their own. For many non-spouse beneficiaries, the SECURE Act's 10-year rule requires the entire account to be distributed by the end of the tenth year following the year of the original owner's death.

However, not every beneficiary is subject to exactly the same rules. Certain eligible designated beneficiaries can qualify for life-expectancy distributions instead of being immediately subject to the standard 10-year rule.

Example: John, age 40, inherits a $50,000 traditional IRA from his uncle. If John is not an eligible designated beneficiary, he will generally need to have the entire inherited IRA distributed by the end of the tenth year following his uncle's death.

Eligible Designated Beneficiaries

The SECURE Act recognizes several categories of eligible designated beneficiaries. These generally include:

• A surviving spouse.
• A minor child of the deceased account owner.
• An individual who is disabled.
• An individual who is chronically ill.
• An individual who is not more than 10 years younger than the deceased account owner.

Eligible designated beneficiaries can have access to more favorable distribution options, including distributions based on life expectancy in qualifying circumstances. A minor child generally receives special treatment only until reaching the applicable age of majority, after which the remaining account is generally subject to a 10-year distribution period.

Trusts, Estates, and Other Beneficiaries

When a trust, estate, or other non-individual entity inherits an IRA, the distribution rules can be more complicated. The result may depend on whether the beneficiary is considered a designated beneficiary under the applicable IRS rules and whether a trust qualifies for special treatment.

If a trust is involved, professional tax and estate-planning advice can be particularly valuable before taking distributions.

Inherited IRA Distribution Rules

Required Minimum Distributions

Required minimum distribution (RMD) rules for inherited IRAs depend on several factors, including the type of IRA, the beneficiary's relationship to the deceased, whether the beneficiary is an eligible designated beneficiary, and whether the original owner had reached their required beginning date.

The rules are different from the RMD rules that apply while the original IRA owner is alive. In particular, an inherited Roth IRA is generally subject to beneficiary RMD rules even though the original owner was not required to take RMDs from their Roth IRA during their lifetime.

The SECURE Act 10-Year Rule

The SECURE Act, enacted in 2019, eliminated the ability of most non-spouse individual beneficiaries to use the traditional "stretch IRA" strategy based on their own long life expectancy.

For many designated beneficiaries who inherited an IRA after 2019, the account must be completely distributed by December 31 of the tenth year following the year of the original owner's death.

Importantly, the 10-year rule does not always mean that you can simply wait until year ten and withdraw the entire account. If the original owner had already reached the required beginning date, annual distributions may also be required during the 10-year period under the applicable RMD rules.

This distinction can make a substantial difference when planning withdrawals and taxes. The IRS finalized regulations governing these beneficiary RMD rules, with the final regulations generally applying beginning in 2025.

Example: Suppose an adult child inherits a traditional IRA from a parent who had already reached the RMD stage. The child may need to take required distributions during the 10-year period and must also completely empty the account by the end of the applicable tenth year.

Tax Implications of an Inherited IRA

Distributions from an inherited traditional IRA are generally taxable as ordinary income to the beneficiary to the extent the distribution represents taxable IRA funds. The distribution is generally included in the beneficiary's income for the year it is received.

There is generally no additional 10% early-distribution tax simply because the beneficiary is under age 59½. This can provide useful flexibility when planning inherited IRA withdrawals.

However, large withdrawals can push a beneficiary into a higher marginal tax bracket. For this reason, taking the entire inherited IRA in one year may create a substantially different tax result from spreading withdrawals over several years.

A beneficiary should consider their other income, expected future income, tax brackets, and the required distribution schedule before deciding how quickly to withdraw the money.

Inherited Roth IRAs vs. Traditional IRAs

Inherited Roth IRAs can provide an important tax advantage because qualified Roth distributions are generally tax-free. However, beneficiaries still have to follow inherited Roth IRA distribution deadlines.

The original owner of a Roth IRA does not have to take RMDs during their lifetime. After the owner's death, however, beneficiaries generally must follow the applicable inherited Roth IRA distribution rules.

The Roth IRA's five-year rule can also matter. If the Roth IRA has not satisfied the applicable five-year holding requirement, earnings may not always receive the same tax-free treatment as they would from a qualified Roth distribution.

Example: Sarah inherits her mother's $70,000 Roth IRA. If the applicable requirements for tax-free treatment are satisfied, Sarah can generally receive distributions without including qualified amounts in her taxable income. Nevertheless, she still needs to follow the inherited Roth IRA distribution deadline.

Strategies for Managing an Inherited IRA

There is no single withdrawal strategy that works for every beneficiary. Consider the following factors before taking distributions:

• Identify your beneficiary status. Determine whether you are a spouse, eligible designated beneficiary, designated beneficiary, or another type of beneficiary.
• Understand the deadline. Determine whether the five-year, ten-year, life-expectancy, or another distribution rule applies to your situation.
• Consider your tax bracket. Spreading taxable withdrawals over multiple years may help avoid unnecessarily large increases in taxable income.
• Consider future income. If your income is expected to be significantly lower in a future year, that may influence the timing of voluntary withdrawals.
• Consider your own retirement accounts. The inherited IRA should be considered alongside your other retirement savings, taxable investments, pensions, and government benefits.
• Use a retirement planning calculator. The Retirementize retirement planning tools can help you model different withdrawal strategies and see how changes in income and withdrawals may affect your retirement plan.

Common Inherited IRA Mistakes to Avoid

• Assuming every beneficiary follows the same rules. Spouses, children, eligible designated beneficiaries, and other beneficiaries can have different options.
• Waiting until the tenth year without checking the RMD rules. In some circumstances, annual distributions are required before the end of the 10-year period.
• Taking a large distribution without considering taxes. A large traditional IRA withdrawal can substantially increase taxable income in the year it is received.
• Ignoring the beneficiary designation. Estate planning documents and beneficiary designations should work together, but the beneficiary designation on the retirement account is particularly important.
• Moving an inherited IRA incorrectly. Non-spouse beneficiaries generally cannot simply roll an inherited IRA into their own IRA. Transfers must follow the applicable inherited-account rules.
• Failing to get professional advice when the situation is complicated. Trusts, multiple beneficiaries, large accounts, and significant tax consequences can justify advice from a qualified tax or financial professional.

Conclusion

Inheriting an IRA can provide valuable financial resources, but the rules can be complicated. Your relationship to the original account owner, the type of IRA, the owner's age at death, and the applicable beneficiary rules can all affect when and how the money must be withdrawn.

Before taking a large distribution, determine which beneficiary rules apply to you and consider the tax consequences of different withdrawal schedules. A thoughtful strategy can help you use the inherited assets while avoiding unnecessary taxes and missed distribution deadlines.

The Retirementize retirement planning tools can help you model retirement income and explore how different withdrawal strategies may affect your overall financial plan.

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