What Happens if You Inherit an IRA?

An inherited Individual Retirement Account (IRA) represents a financial asset passed on to a beneficiary following the original owner’s death. Unlike a standard IRA, which an individual establishes for their own retirement savings, an inherited IRA is subject to a distinct set of regulations governing its management and eventual distribution. These specific rules determine how and when funds can be withdrawn, and they significantly influence the tax implications for the beneficiary. Navigating an inherited IRA requires understanding these unique provisions to ensure proper handling and to optimize financial outcomes.

Understanding Inherited IRA Fundamentals

Inherited IRAs retain the tax characteristics of the original account. For instance, a Traditional IRA typically consists of pre-tax contributions and tax-deferred growth, meaning distributions are generally taxed as ordinary income. Conversely, a Roth IRA, funded with after-tax contributions, usually allows for qualified distributions to be entirely tax-free for the beneficiary, provided certain conditions are met. Other retirement plans, such as SEP and SIMPLE IRAs, generally align with Traditional IRA rules.

The beneficiary’s classification determines the rules for an inherited IRA. A spousal beneficiary is the surviving spouse, who typically has the most flexible options. Non-spousal beneficiaries include any individual or entity other than the spouse, such as children, siblings, or trusts.

The SECURE Act introduced distinctions within the non-spousal category: a “designated beneficiary” is an individual with an ascertainable life expectancy, while a “non-designated beneficiary” refers to an entity like an estate or charity. An “eligible designated beneficiary” is a specific subset of non-spousal beneficiaries, including minor children of the decedent, disabled or chronically ill individuals, or individuals not more than 10 years younger than the decedent. These eligible beneficiaries may qualify for more extended distribution periods.

Options for Spousal Beneficiaries

Spousal beneficiaries have flexible options when inheriting an IRA. One common choice allows a surviving spouse to roll over the inherited IRA funds into their own existing IRA or establish a new IRA. This treats the inherited assets as the spouse’s own retirement savings, subject to their RMDs once they reach the applicable age. This strategy provides significant tax deferral benefits, allowing funds to continue growing tax-deferred until the spouse’s own retirement.

A spouse can also treat the inherited IRA as their own without a formal rollover. This is typically done by making contributions or not taking distributions that would be required for an inherited IRA. By doing so, the spouse assumes full ownership, and the account becomes subject to their personal IRA rules, including their age-based RMD schedule. This can benefit younger spouses who wish to avoid immediate distribution requirements.

Finally, a spouse can choose to remain an inherited IRA beneficiary, keeping the account separate from their own retirement savings. Under this approach, the spouse is subject to RMDs based on their own life expectancy, or they may delay distributions until the deceased spouse would have reached the age for RMDs. This option might be considered if the surviving spouse is younger and does not need immediate access to funds, or for estate planning. The decision among these options depends on the spouse’s age, financial needs, and overall estate planning goals.

Options for Non-Spousal Beneficiaries

Non-spousal beneficiaries face different inherited IRA rules, primarily governed by the SECURE Act. For most designated non-spousal beneficiaries, the “10-year rule” applies. This requires the entire inherited IRA balance to be distributed by the end of the tenth calendar year following the original owner’s death, regardless of whether the original owner had begun taking RMDs. While annual distributions are not required within this period, the account must be emptied by the deadline, potentially leading to a large taxable event in the final year.

Specific exceptions to the 10-year rule exist for certain “eligible designated beneficiaries.” A minor child of the decedent, for example, may stretch distributions over their life expectancy until they reach the age of majority (typically 21), at which point the 10-year rule then applies. Individuals who are disabled or chronically ill, as defined by IRS guidelines, can generally continue to take distributions over their own life expectancy, providing a longer period for tax deferral.

Beneficiaries not more than 10 years younger than the decedent also qualify as eligible designated beneficiaries and can take distributions over their life expectancy. This acknowledges that individuals close in age to the deceased may have similar financial planning needs. These eligible designated beneficiary categories depart from the strict 10-year payout period, offering more flexibility in managing inherited assets and their tax implications. Understanding these distinctions is important for non-spousal beneficiaries to plan distributions effectively.

Tax Implications of Inherited IRA Distributions

The tax treatment of inherited IRA distributions depends on the IRA type. For an inherited Traditional IRA, distributions are generally taxed as ordinary income to the beneficiary in the year received. This is because contributions are typically made with pre-tax dollars, and earnings grow tax-deferred. The amount included in the beneficiary’s gross income will be subject to their marginal income tax rate, similar to other taxable income.

Conversely, qualified distributions from an inherited Roth IRA are typically received tax-free. This is because contributions to Roth IRAs are made with after-tax dollars. A distribution is generally considered qualified if the Roth IRA has been open for at least five years and the distribution occurs after the original owner’s death.

Required Minimum Distributions (RMDs) are an important aspect of inherited IRA taxation for certain beneficiaries. While the 10-year rule for many non-spousal beneficiaries allows flexibility in timing distributions, RMDs still apply to eligible designated beneficiaries and spousal beneficiaries who do not roll over the account. These RMDs are calculated based on IRS life expectancy factors and must be taken annually to avoid a penalty, typically 25% of the amount that should have been withdrawn. Understanding these tax rules helps beneficiaries manage funds efficiently and avoid unexpected liabilities or penalties.

Initiating and Managing Inherited IRA Distributions

After understanding options and tax implications, beneficiaries can initiate and manage inherited IRA distributions. The first step involves contacting the financial institution or custodian where the deceased individual’s IRA was held. This could be a bank, brokerage firm, or mutual fund company. They will provide specific instructions and required forms for initiating the transfer or establishment of the inherited IRA.

To process the inheritance, the custodian will require documentation proving the account owner’s death and the beneficiary’s identity. This usually includes a certified copy of the death certificate, proof of identity (such as a driver’s license or passport), and completed beneficiary designation forms. If there was no designated beneficiary, or if the beneficiary is an estate or trust, additional legal documents like letters testamentary or trust agreements may be necessary to establish legal authority.

After documentation is submitted, the custodian will establish the inherited IRA account in the beneficiary’s name, often titled to indicate its inherited status (e.g., “John Doe as beneficiary of Jane Doe IRA”). Once established, the beneficiary can request distributions according to their beneficiary type. This usually involves completing a distribution request form, specifying the amount and frequency of withdrawals, and choosing how funds will be delivered, such as direct deposit or check.