By: Tyler Kang
Inheriting an Individual Retirement Account (IRA) is never just a financial event, it’s deeply personal. The emotional toll of losing a loved one often coincides with the need to make important financial decisions. Understanding what to do with an inherited IRA can be overwhelming, especially given the evolving rules and tax implications.
An inherited IRA, also known as a Beneficiary IRA, is an account established for someone who inherits retirement assets after the passing of the original account holder. The rules governing inherited IRAs vary significantly depending on your relationship to the deceased, the type of IRA, and when the original owner passed away.
Factors to consider:
- Traditional vs. Roth IRA: Tax treatment and distribution rules differ.
- Your relationship to the deceased: Spousal and non-spousal beneficiaries have different options.
- Distribution method: Will you take a lump sum, transfer to an inherited IRA, or (if eligible) roll it over?
- Timing of the original account owner’s death: Did they pass before or after 2020? Were they already taking Required Minimum Distributions (RMDs)? These details affect your RMD requirements.
Inheriting an IRA from a Spouse
You have options that other beneficiaries do not. You can rollover the IRA into your own IRA (as long as they are the same type of IRA), into an inherited IRA, or take a lump sum distribution. The key advantage of maintaining an IRA is the opportunity for continued tax-deferred or tax-free growth, depending on if it’s a traditional or Roth IRA. The key advantage of rolling the account into your own IRA is the ability to delay RMDs until age 73, and difference in RMD calculation versus an inherited IRA.
Inheriting an IRA for Non-spouses
The first step is identifying whether you are considered an eligible or non-eligible designated beneficiary to determine what set of rules apply to your unique situation. Eligible designated beneficiaries are:
- Chronically ill or disabled non-spouse beneficiaries
- Non-spouse beneficiaries not more than 10 years younger than the account owner who passed
- A minor child of the account owner (biological or legally adopted) until the child is 21 years old. Once the beneficiary reaches 21 years of age, they have 10 years to deplete the account.
All other non-spouse beneficiaries must use the new 10-year rule to deplete the account, where the account must be drawn down by the end of the 10th year following the decedent’s passing.
Recent Legislation Changes
In 2020 and 2022, the Secure Act and Secure 2.0 Act were passed and changed the rules surrounding inherited IRAs. The Secure Act eliminated the stretch provision for most, where beneficiaries were allowed to use their life expectancy to minimize IRA withdrawals overtime, creating the 10-year rule. New rules:
- 10-year rule for most non-spouse beneficiaries
- Exceptions for eligible designated beneficiaries
- Secure 2.0 Act
- Raised the age that account owners must begin taking RMDs
- 25% excise tax on the RMD amount not withdrawn
Inheriting an IRA can have a profound impact on your financial life. It often represents the result of someone’s lifetime of savings and thoughtful planning. Given the complexity of the current laws, the changing regulations, and the potential tax consequences, it’s critical to work with a financial professional who can help you:
- Understand your options.
- Navigate distribution rules.
- Maximize the legacy left to you.
As an RIA firm, we often guide clients through this process. It’s a challenging but rewarding part of financial planning, helping people honor the legacy of their loved ones by making informed, strategic decisions with the assets left behind.
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