Inherited IRA Beneficiary Options and Withdrawal Rules

Inherited IRA Rules For Beneficiaries

It is never easy to lose a loved one. When a loved one dies, financial issues are often a part of the grieving process.

Executing the will is one of the most common financial concerns. It also involves reviewing other aspects of their inheritance plan. Complex rules and tax implications can make it difficult for listed beneficiaries to inherit assets like Individual Retirement Accounts (IRA).

What is an Inherited IRA and How Does It Work?

An inherited IRA, also known as a beneficiary IRA or a beneficiary IRA (or IRA), is an account that opens when someone inherits an IRA from the original owner. A spouse, a relative, an estate, trust, etc. could be the beneficiary.

What is an Inherited IRA?

An inherited IRA can be opened for any type of IRA. This applies to traditional and Roth IRAs. It also includes rollover IRAs. SEP-IRAs, simple IRAs, and rollover IRAs. As inherited IRAs, employer-sponsored retirement plans (401(k), 403(b), and other plans) can be opened.

Generally, assets in an IRA account that have been owned by the owner must be transferred to a new IRA named for the beneficiary when the owner dies. This is called an inherited IRA. You cannot make additional contributions to an inherited IRA.

Regardless of the type of IRA being inherited, inherited IRAs can be treated in the same manner. The tax treatment of inherited IRAs depends on the type of IRA it was originally (e.g. was it funded with pretax or posttax dollars). ).

The IRS offers detailed guidance for inherited IRA beneficiaries. To report an inherited IRA or its distributions to the IRS, you must file IRS Forms 5498 and 1099-R.

What should you do with an inherited IRA?

You may feel the instinct to collect an inherited IRA's funds by simply taking a lump-sum distribution if you are a beneficiary. This could increase your taxable income and lead to tax-deferred growth.

Depending on whether the IRA was owned by a spouse or not, and if it is a Roth or traditional IRA, there may be different inheritance rules. As every case is different, it's a good idea for you to talk about inherited IRAs with a fiduciary advisor.

Traditional IRA: Spouse Inherited Guidelines

You can inherit the traditional IRA of your spouse by a spousal gift. By naming yourself the owner of the IRA, you can treat it as if it were your own retirement account.

You can rollover the deceased's IRA as the beneficiary into a qualified employer, qualified annuity, tax-sheltered and/or deferred compensation plan of a local or state government, such as a 457(b). Rolling over the deceased's IRA to your own qualified retirement plan has the advantage of allowing you to defer required minimum distributions (RMDs), of funds in a traditional IRA up until 72. You will be subject to a 10% penalty if you take a distribution or roll the funds over into a qualified plan.

The IRS states that a spouse who receives a distribution of their spouse's IRA can roll it over to an IRA owned by the surviving spouse, provided that the distribution is not a mandatory distribution. This applies regardless of whether the surviving spouse is the sole beneficiary of the IRA.

Roth IRA: Spouse Inherited Guidelines

You can also inherit the Roth IRA of your spouse by a spousal gift. You can access the money at any time. However, the earnings are generally taxable until you reach age 60 1/2 and complete the five-year holding period. This option is only available if the IRA's sole beneficiary is you.

You can open an inherited Roth IRA, using either the 10-year or life expectancy methods. RMDs are mandatory for the first. You can however postpone distributions to the second option:

  • The 72nd birthday of your spouse
  • The year ending with the death of your spouse

The money can be used at any time up to the end of the tenth anniversary following the death of your spouse. All the money must then be distributed. The 10-year method allows distributions to be made within the five-year period provided the holding period is met. You will not be subject to the 10% penalty for early withdrawal.

The final option is to have the Roth IRA distributed in its entirety by way of a lump-sum distribution. This option doesn't require you to establish an Inherited IRA and all assets will immediately be distributed. If the account was less five years old at the time of your spouse's death, earnings will be taxed.

Traditional IRA: Non-Spousal Inherited Guidelines

If your spouse inherits a traditional IRA, you are eligible to be a designated beneficiary. Your withdrawal options will depend on the age of the deceased.

If the deceased person was less than 72 years old at the time of their death, you have two options for withdrawing your funds:

  • Use the life expectancy method to open an inherited IRA
  • Use the 10-year method to open an inherited IRA
  • You can take a lump sum distribution

Your withdrawal options are limited if the deceased was aged 72 or older

  • Open an inherited IRA by using the life expectancy method
  • Take a lump-sum distribution

You must be:

  • A minor child of the account holder who has died
  • Chronically ill or disabled
  • The deceased beneficiary must not be more than 10 years older than him.

Roth IRA: Non-Spousal Inherited Guidelines

If your spouse inherits a Roth IRA, and you are eligible to be a designated beneficiary, you may open an inherited IRA by using either the life expectancy or 10-year methods.

Inherited IRAs for non-spouse beneficiaries, designated beneficiaries

The SECURE ACT contained new guidelines for nonspouse beneficiaries. While non-spouse beneficiaries may be able to take a lump sum distribution as well, this could lead to more taxable income, as we have already noted.

Non-spouses cannot transfer money from the deceased IRA to their own retirement accounts or make contributions to the deceased IRA, unlike spousal beneficiaries.

The SECURE ACT requires that IRAs inherited after 2019 must be distributed to non-spouse beneficiaries within 10 years of their original owners' death. This withdrawal rule may not apply to those who are permanently or chronically ill or younger than 10 years. The rule can also be applied to minor children who are the direct descendants of the deceased until they reach the age of majority in their state.

You should know that you don't have to distribute funds every year. As long as the total amount is distributed within 10years, there is no requirement. Failure to meet this 10-year deadline could result in a 50% penalty.

Depending on whether you inherit a Traditional IRA or a Roth IRA, you may be able to adjust the distribution timeline within the 10-year limit. To avoid taking out large sums in one year, it may be beneficial for a traditional IRA to distribute each year. You may be subject to a higher tax rate if you take out a large amount at once. If you inherit a Roth IRA it might make sense to keep the funds in the Inherited IRA as long as possible. The Inherited IRA will allow the account to continue growing tax-free. You won't have to pay taxes when funds are distributed from a Roth IRA.

Non-Designated Beneficiaries

An IRA can be passed on to a beneficiary, but not all beneficiaries must be listed. Most likely, the distribution method for inheritors through estates will follow the old rules before the SECURE Act.

Below is a list of actions that are most likely to be used for the distribution of assets in an IRA.

  • Give the inherited retirement account to someone else.
  • You can take a lump sum distribution.
  • If the account owner dies before the RMD age, distribute the assets within five year.

What is the tax treatment of an Inherited IRA?

Tax treatment for inherited IRAs will depend on the type and withdrawal method chosen, as well as the type and type of IRA the deceased owned. Before you decide how to proceed, we recommend that you consult your tax advisor or CPA. They will help you to understand the tax implications of your inheritance, and can set up a distribution schedule that avoids tax penalties.

Next steps

You can inherit an IRA as a beneficiary. It is important to understand your options and the possible outcomes. Consultation with a professional can help you avoid unpleasant surprises such as penalties or taxes.

These are some additional steps that you can take in order to ensure your financial health when you inherit an IRA.

  1. Personal Capital's financial tools are free to sign up for. These include the Retirement Planner – a sophisticated retirement planner that will show you how your inherited IRA affects your retirement readiness. You can also track your net worth and analyze your portfolio to spot hidden fees.
  2. Find a fiduciary advisor to help you navigate the rules surrounding your inherited IRA.

Personal Capital: Get started


How To

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By: Shannon Lynch, CFP®
Title: Inherited IRA Beneficiary Options and Withdrawal Rules
Sourced From:
Published Date: Thu, 10 Nov 2022 14:00:18 +0000

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