The distribution rules for inheriting an IRA are highly complicated, and have changed since the SECURE Act of 2019. Unlike other kinds of inheritances, an inherited IRA is governed by IRS rules about how and when the money can be distributed, and depend on whether the beneficiary is an eligible designated beneficiary or a non-spouse beneficiary.
Other factors that influence inherited IRA distributions include: the age of the original account holder when they died, and whether the account holder had started taking required minimum distributions (RMDs) before their death.
This story does not address non-individual beneficiaries, such as a charity.
Key Points
• An inherited IRA refers to funds bequeathed by a deceased IRA owner to one or more beneficiaries.
• It can also describe a specific type of IRA that a beneficiary can open to receive inherited funds, which is subject to different terms than an ordinary IRA.
• The factors that impact how a beneficiary must handle inherited IRA assets include whether they are a spouse or non-spouse of the deceased, and whether the original account owner had started taking required minimum distributions (RMDs).
• Thanks to the SECURE Act of 2019, there are more favorable options for eligible designated beneficiaries, who have the option of stretching out withdrawals longer, in most cases.
• Eligible designated beneficiaries include a spouse, a minor child, someone who is chronically ill or disabled, per IRS rules, or an individual up to 10 years younger than the original account holder.
What Is an Inherited IRA?
When an IRA owner passes away, the funds in their account are bequeathed to their beneficiary (or beneficiaries), who can open an inherited IRA to accept the funds, or they may be able to rollover the money to their own IRA account.
• The original retirement account could be any type of IRA, such as a Roth IRA, traditional IRA, SEP IRA, or SIMPLE IRA.
• The deceased’s 401(k) or other qualified retirement plan can also be used to fund an inherited IRA, but the distribution terms would be specified by the plan administrator.
If you inherit an IRA, the following conditions determine what you can do with the funds:
• Your relationship to the deceased account holder (e.g., are you a spouse or non-spouse)
• The original account holder’s age when they died
• Whether they had started taking their required minimum distributions (RMDs) before they died
• The type of retirement account involved
Basic Rules About Withdrawals
There are a number of options available for taking distributions, depending on your relationship to the deceased. At minimum, most beneficiaries can either take the inherited funds as a lump sum, or they can follow the 10-year rule.
The 10-year rule regarding inherited IRAs means that the account must be emptied by the 10th year following the death of the original account holder.
In all cases, the tax rules governing the type of IRA (tax-deferred vs. Roth) apply to the inherited IRA as well. So withdrawals from an inherited traditional IRA are taxed as income. Withdrawals from an inherited Roth IRA are generally tax-free (details below).
Exceptions for Eligible Designated Beneficiaries
Withdrawal rules for inherited IRAs are different for eligible designated beneficiaries.
According to the IRS, an eligible designated beneficiary refers to:
• The spouse or minor child of the original account holder.
• A minor child is under age 21, and can be biological or legally adopted.
• An individual who meets the IRS criteria for being a disabled or chronically ill person.
• A person who is no more than 10 years younger than the IRA owner or plan participant.
If you qualify as an eligible designated beneficiary, and you are a non-spouse, here are the options that pertain to your situation:
• If you’re a minor child, you can extend withdrawals until you turn 21.
• If you’re disabled or chronically ill, or not more than 10 years younger than the deceased, you can extend withdrawals throughout your lifetime.
Get a 1% IRA match on rollovers and contributions.
Double down on your retirement goals with a 1% match on every dollar you roll over and contribute to a SoFi IRA.1
1Terms and conditions apply. Roll over a minimum of $20K to receive the 1% match offer. Matches on contributions are made up to the annual limits.
What Are the RMD Rules for Inherited IRAs?
Assuming the original account holder had not started taking RMDs, and you are the surviving spouse and sole beneficiary of the IRA, you have a few options:
Rollover the Funds to Your Own IRA
If you rollover the funds to your own IRA, new or existing, you have to do an apples-to-apples rollover (tax deferred to tax deferred, Roth to Roth.) In addition:
• Once rolled over, inherited funds become subject to regular IRA rules, based on your age. Meaning: You have to wait to take distributions until you’re 59 ½ (or potentially owe a 10% penalty), in the case of a tax-deferred account rollover.
• You can keep contributing to the IRA.
• RMDs from your own IRA are subject to your life expectancy table and likely smaller, which may be advantageous from a tax perspective.
Move the Funds to an Inherited IRA
You can also set up an inherited IRA in order to receive the funds you’ve inherited. Again the accounts must match (e.g., funds from a regular Roth IRA must be moved to an inherited Roth IRA). Inherited IRAs follow slightly different rules.
• You cannot contribute to the IRA.
• You must take RMDs every year, but these can be based on your own life expectancy
• Distributions from a tax-deferred account are taxable, but the 10% penalty for early withdrawals before age 59½ doesn’t apply.
If the Deceased Had Started Taking RMDs
If the original account holder had started taking RMDs, you (the spouse) have to take the rest of the RMDs for that year they died in. Then you switch to your own RMD, from there on out, each year.
Some people prefer to open their inherited IRA account with the same firm that initially held the money for the deceased. However, you can open an IRA with almost any bank or brokerage.
When You Inherit from a Non-Spouse
If you are a non-spouse beneficiary, here’s what to consider. First, decide whether you meet the criteria for being an eligible designated beneficiary, or a designated beneficiary.
If You’re a Non-Spouse, Eligible Designated Beneficiary
Non-spouse eligible designated beneficiaries include: chronically ill or disabled non-spouse beneficiaries; non-spouse beneficiaries not more than 10 years younger than the original deceased account holder; or a minor child of the account owner.
Once a minor child beneficiary reaches 21, they have 10 years to deplete the account.
If You’re a Non-Spouse Designated Beneficiary
All other non-spouse beneficiaries (including grandchildren and other relatives) must follow the 10-year rule and deplete the account by the 10th year following the death of the account holder.
After that 10-year period, the IRS will impose a 50% penalty tax on any funds remaining.
Multiple Beneficiaries
If there is more than one beneficiary of an inherited IRA, the IRA can be split into different accounts so that there is one for each person.
However, in general, you must each start taking RMDs by December 31st of the year following the year of the original account holder’s death, and all assets must be withdrawn from each account within 10 years (aside from the exceptions noted above).
It’s Possible to Disclaim Assets
You can also refuse an inherited IRA. In that case, the funds will pass to the next eligible beneficiary. Generally, the choice to disclaim inherited IRA assets must be completed within nine months of the account holder’s death.
Inherited IRA Examples
These are some of the different instances of inherited IRAs and how they can be handled.
Spouse inherits and becomes the owner of the IRA: When the surviving spouse is the sole beneficiary of the IRA, they can opt to become the owner of it by rolling over the funds into their own IRA. The rollover must be done within 60 days.
This could be a good option if the original account holder had already started taking RMDs, because it delays the RMDs until the surviving spouse turns 73.
Non-spouse designated beneficiaries: An adult child or friend of the original IRA owner can open an inherited IRA account and transfer the inherited funds into it.
They generally must start taking RMDs by December 31 of the year after the year in which the original account holder passed away. And they must withdraw all funds from the account 10 years after the original owner’s death.
Both a spouse and a non-spouse inherit the IRA: In this instance of multiple beneficiaries, the original account can be split into two new accounts. That way, each person can proceed by following the RMD rules for their specific situation.
How Do I Avoid Taxes on an Inherited IRA?
Money from IRAs is generally taxed upon withdrawals, so your ordinary tax rate would apply to any tax-deferred IRA that was inherited — traditional, SEP IRA, or SIMPLE IRA.
However, if you have inherited the deceased’s Roth IRA, which allows for tax-free distributions, you should be able to make tax-free withdrawals of contributions and earnings, as long as the original account was set up at least five years ago (a.k.a. The five-year rule). As with an ordinary Roth account, you can withdraw contributions tax free at any time.
The Takeaway
Once you inherit an IRA, it’s wise to familiarize yourself with the inherited IRA rules and requirements that apply to your situation. No matter what your circumstance, inheriting an IRA account has the potential to put you in a better financial position for your own retirement.
Ready to invest for your retirement? It’s easy to get started when you open a traditional or Roth IRA with SoFi. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
FAQ
Are RMDs required for inherited IRAs in 2023?
The IRS recently delayed the final RMD rule changes regarding inherited IRAs to calendar year 2024. What this means is that the IRS will, in some cases, waive penalties for missed RMDs on inherited IRAs in 2023 — but only if the original owner died after 2019 and had already started taking RMDs.
What are the disadvantages of an inherited IRA?
The disadvantages of an inherited IRA include: knowing how to navigate and follow the complex rules regarding distributions and RMDs, and understanding the tax implications and potential penalties for your specific situation.
How do you calculate your required minimum distribution?
To help calculate your required minimum distribution, you can consult IRS Publication 590-B. There you can find information and tables to help you determine what your specific RMD would be.
Photo credit: iStock/shapecharge
SoFi Invest® INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
SOIN-Q324-053