What Happens When You Inherit an IRA From a Parent?

Inheriting an Individual Retirement Account (IRA) from a parent involves navigating specific rules that differ from managing your own retirement savings. Understanding these distinctions is important for properly handling the inherited assets, impacting growth and tax obligations. Careful attention helps beneficiaries avoid penalties and integrate funds into financial plans.

Immediate Steps After Inheritance

First, identify the account’s existence. This information often comes through estate documents, a will, or direct communication from the deceased parent’s financial advisor or the financial institution holding the account. Having the original owner’s statements or account numbers can expedite this process.

Next, contact the IRA custodian or financial institution holding the account to initiate the claim process. They will provide necessary forms and guidance.

The financial institution will require documents like a certified death certificate and your identification to verify your identity and the original owner’s death. Promptly providing these allows the custodian to transfer assets into an inherited IRA account, also known as a beneficiary IRA. This account is distinct from your personal IRA.

Understanding Beneficiary Status and Distribution Options

Your beneficiary status dictates distribution options for an inherited IRA. This status is crucial for navigating the rules.

A surviving spouse has the most flexibility. They can roll the inherited IRA into their own existing IRA, treating it as their own retirement account and deferring distributions until their own required beginning date. Alternatively, a spouse can keep the account as an inherited IRA, subject to beneficiary rules but retaining unique spousal advantages.

Most non-spousal beneficiaries, or designated beneficiaries, fall under the SECURE Act’s “10-year rule.” This rule mandates the entire inherited IRA balance must be distributed by December 31st of the calendar year containing the 10th anniversary of the original owner’s death. For example, if the owner died in 2025, the IRA must be fully distributed by December 31, 2035.

There are specific exceptions to the 10-year rule for certain “eligible designated beneficiaries” who may still be able to use the “stretch” option, allowing distributions over their life expectancy. These exceptions include individuals who are chronically ill, disabled, or not more than 10 years younger than the deceased IRA owner. Minor children of the deceased IRA owner are also considered eligible designated beneficiaries, but they must begin taking distributions under the 10-year rule once they reach the age of majority.

If the beneficiary is not an individual, such as an estate, trust, or charity, different rules apply. In these cases, the “5-year rule” may apply, requiring all funds to be distributed by the end of the fifth year following the original owner’s death. Alternatively, if the original owner had already begun taking required minimum distributions (RMDs), the beneficiaries might be able to continue distributions over the deceased owner’s remaining life expectancy.

A beneficiary always has the option to take a lump-sum distribution of the entire inherited IRA balance at any time. While this provides immediate access to the funds, it can lead to significant immediate tax consequences, as the entire amount may be subject to income tax in the year of withdrawal. Understanding the distinction between Traditional and Roth inherited IRAs is also crucial for distribution planning. While distributions from an inherited Traditional IRA are generally taxable, qualified distributions from an inherited Roth IRA are typically tax-free, assuming the original owner met the five-year aging period for their Roth IRA.

Tax Considerations for Inherited IRA Distributions

Distributions from an inherited Traditional IRA are generally taxable as ordinary income in the year they are received. This means the amount withdrawn is added to your other income for the year and taxed at your marginal income tax rate. An exception exists if the original owner made non-deductible contributions to the IRA, in which case a portion of the distributions may be tax-free.

Conversely, distributions from an inherited Roth IRA are typically tax-free, provided the distribution is considered “qualified.” For an inherited Roth IRA, a distribution is qualified if it is made after the end of the five-year period beginning with the first tax year for which the original owner made a contribution to any Roth IRA. The five-year period applies to the original owner’s account, not to the beneficiary’s holding period.

Required Minimum Distributions (RMDs) apply to most inherited Traditional IRAs. Even under the 10-year rule for non-spousal beneficiaries, annual RMDs may be required if the original owner died on or after their required beginning date for distributions. For eligible designated beneficiaries using the life expectancy method, annual RMDs are calculated based on the beneficiary’s life expectancy. Although inherited Roth IRAs are subject to RMD rules for beneficiaries, the distributions themselves remain tax-free once qualified.

Failing to take a required minimum distribution when due can result in a penalty. The penalty for missing an RMD is generally 25% of the amount that should have been distributed. This penalty can be reduced to 10% if the RMD is taken, and the penalty is reported on a tax return, within a specific correction period.

All distributions from an inherited IRA, whether taxable or not, will be reported to the Internal Revenue Service (IRS) on Form 1099-R. This form details the amount distributed and indicates whether it is a normal distribution, an early distribution, or an inherited distribution. You will receive this form from the IRA custodian at the beginning of the year following the distribution.

Administering Your Inherited IRA

To take a distribution, contact the IRA custodian directly. They will provide forms or instructions. Specify that the distribution is from an inherited IRA and indicate the desired amount.

When requesting a distribution, you have the option to have federal income taxes withheld from the payment. This can help manage your tax liability throughout the year, similar to how taxes are withheld from a paycheck. Deciding whether to withhold taxes, and at what rate, depends on your individual tax situation and other income sources.

Maintaining accurate records of all distributions received from the inherited IRA is important. This includes keeping copies of all withdrawal requests, custodian statements, and particularly Form 1099-R, which details the distributions made during the year. Good record-keeping simplifies tax preparation and provides a clear history of your inherited funds.

Distributions from an inherited IRA must be reported on your federal income tax return. For most individuals, this will involve reporting the taxable amount on Form 1040. The information provided on Form 1099-R will guide you in properly reporting these amounts.

Staying aware of your distribution deadlines is important to avoid penalties. For non-spousal beneficiaries subject to the 10-year rule, ensuring the entire balance is distributed by the final deadline is important. Similarly, beneficiaries taking RMDs annually must adhere to the yearly distribution requirements.