How to Set Up an Inherited IRA Account

An inherited IRA is a specialized retirement account established when an individual receives retirement assets after the original owner’s death. It differs from a personal IRA due to specific rules and distribution requirements unique to inherited assets. The purpose of an inherited IRA is to allow inherited funds to continue growing with tax advantages, while ensuring they are eventually distributed according to IRS regulations.

Understanding Inherited IRA Beneficiary Types and Their Implications

The rules governing an inherited IRA depend on the beneficiary’s relationship to the original account owner. Spouses have the most flexible options. They can roll inherited assets into their own IRA, deferring distributions until their own required beginning date (RBD) for RMDs. Alternatively, a spouse can transfer assets into an inherited IRA, maintaining the deceased’s name, which may be beneficial if they need access to funds before age 59½ without an early withdrawal penalty.

Non-spousal beneficiaries face different rules. “Eligible designated beneficiaries” include minor children of the deceased, individuals who are disabled or chronically ill, and beneficiaries not more than 10 years younger than the deceased. These beneficiaries may stretch distributions over their own life expectancy, allowing for continued tax-deferred growth. For minor children, this rule applies until they reach the age of majority, typically 21, after which the 10-year rule generally takes effect.

Other non-spousal beneficiaries are subject to the “10-year rule” for deaths occurring after 2019. This rule mandates that the entire inherited IRA account must be fully distributed by December 31 of the tenth year following the original owner’s death. Annual distributions are not always required during this period if the original owner died before their RBD, but the full balance must still be withdrawn by the deadline.

Inherited IRAs left to non-person beneficiaries, such as trusts or estates, have less flexible distribution rules. If an IRA is inherited by an estate or a trust that does not qualify as a “look-through” trust, the “5-year rule” may apply if the original owner died before their required beginning date for RMDs. Under this rule, the entire account must be distributed within five years of the owner’s death. If the original owner died on or after their RBD, distributions for non-person beneficiaries are based on the deceased owner’s remaining life expectancy at the time of death.

Gathering Information and Completing Account Setup Forms

Setting up an inherited IRA requires specific documentation. A certified copy of the deceased account owner’s death certificate is the most important document, verifying death and essential for asset transfer. The beneficiary’s valid identification, such as a driver’s license or state ID, is also required. Information about the deceased’s original IRA account, including account numbers and custodian, is necessary to facilitate the transfer.

Beneficiaries must decide whether to keep the inherited IRA with the deceased’s original custodian or transfer it to a new financial institution. Consider factors like fees, investment options, and customer service. Researching and comparing different custodians’ offerings can help in this decision.

Once a custodian is chosen, obtain the correct forms to establish the inherited IRA. These forms are often specific to the custodian and may include a “Beneficiary Transfer Form” or an “Inherited IRA Application.” Most custodians provide these forms on their websites or through their beneficiary services department. Use the most current versions to avoid delays.

Completing the forms accurately is important. The inherited IRA account must be titled correctly, typically as “John Doe, Beneficiary of Jane Smith Deceased IRA.” This titling is crucial for tax purposes and to distinguish it from personal IRA accounts. Personal information for the beneficiary, including Social Security number and contact details, must be entered precisely. Details about the deceased’s original IRA, such as account number and type (e.g., traditional or Roth), are also required. The beneficiary must indicate their specific beneficiary type and chosen distribution option. All required fields must be signed and dated by the beneficiary to certify the information.

The Process of Submitting Your Inherited IRA Account Application

After gathering information and completing the account setup forms, submit the application package to the chosen custodian. Submission methods include mailing physical forms, using an online portal, or submitting documents in person. Confirm the preferred method with the custodian for timely processing.

After submission, beneficiaries should anticipate receiving confirmation, such as a confirmation number or acknowledgment letter. Custodians often provide processing time estimates, ranging from a few business days to several weeks. Keep a record of all submitted documents and confirmation numbers for future reference.

Follow up with the custodian to ensure the application is progressing. If an online portal is available, beneficiaries can track their application status. Otherwise, contact the custodian’s customer service or beneficiary services department after the estimated processing time to confirm receipt and inquire about the account opening status. This proactive approach helps address potential issues promptly.

Required Minimum Distribution Rules for Inherited IRAs

Required Minimum Distributions (RMDs) are annual withdrawals from inherited IRAs, ensuring tax-deferred savings are eventually taxed. These rules vary based on the beneficiary’s relationship to the deceased and the date of death. Understanding these requirements is important to avoid penalties.

For most non-spousal beneficiaries subject to the “10-year rule” (for deaths after 2019), the entire inherited IRA balance must be distributed by December 31 of the tenth year following the original owner’s death. Recent IRS guidance clarifies that annual RMDs are required during years 1-9 if the original owner was already taking RMDs at the time of death. The full account balance must still be withdrawn by the end of the 10th year.

“Eligible designated beneficiaries” may utilize the “life expectancy rule.” These beneficiaries can stretch distributions over their own life expectancy, calculated using IRS life expectancy tables. Distributions generally must begin by December 31 of the year following the year of the original owner’s death.

Spousal beneficiaries have additional RMD options. If a spouse chooses to treat the inherited IRA as their own, RMDs are delayed until they reach their own required beginning date, currently age 73 for most. If they establish an inherited IRA in their name, they can generally delay RMDs until the later of December 31 of the year following the original owner’s death or December 31 of the year the original owner would have reached age 73.

RMDs for the year of the original account owner’s death must be taken if they had not done so prior to passing. The RMD deadline for all beneficiaries is generally December 31 of each year, following the year of death, depending on the specific rule that applies. Failing to take a required minimum distribution can result in a significant penalty, typically 25% of the amount that should have been withdrawn, though it can be reduced to 10% if corrected promptly.

Key Tax Considerations for Inherited IRAs

Distributions from an inherited traditional IRA are taxable as ordinary income to the beneficiary in the year received. This income is added to the beneficiary’s other taxable income and is subject to their individual income tax rate. Since contributions to traditional IRAs are typically pre-tax, all withdrawals, including earnings, become taxable upon distribution.

Qualified distributions from an inherited Roth IRA are generally tax-free. Contributions to Roth IRAs are made with after-tax dollars, and earnings grow tax-free, provided conditions are met, such as the account being open for at least five years before the original owner’s death. If the five-year holding period was not met by the original owner, only the earnings portion of the distribution would be taxable; contributions remain tax-free.

The concept of “basis” applies if the original owner made non-deductible contributions to their traditional IRA. These contributions represent money already taxed, so they are not taxed again when distributed. Keeping records of such contributions, often reported on IRS Form 8606, is important for beneficiaries to avoid double taxation.

Distributions from inherited IRAs may also be subject to state income taxes, depending on the beneficiary’s state of residence. State tax laws vary, so beneficiaries should consult their state’s tax regulations or a tax professional. Beneficiaries will receive IRS Form 1099-R from the IRA custodian, reporting the total distributions taken. This form is essential for accurately reporting income on federal and state tax returns.

Distributions from inherited IRAs are generally not subject to the 10% early withdrawal penalty, regardless of the beneficiary’s age. This differs from withdrawals from a personal IRA before age 59½, which typically incur this penalty unless an exception applies. This exemption provides beneficiaries with flexibility to access inherited funds without immediate age-related penalties, though distributions remain subject to ordinary income tax for traditional IRAs.