What to Do With an Inherited IRA From a Parent?

Inheriting an Individual Retirement Account (IRA) from a parent involves a complex set of rules and decisions. These accounts carry specific regulations concerning who can inherit them, how distributions must be taken, and the associated tax implications. Navigating these requirements effectively is important for beneficiaries to manage the inherited assets and avoid potential penalties.

Determining Beneficiary Status and Initial Choices

Determining your beneficiary status is the first step when inheriting an IRA, as it dictates available options and rules. The IRS categorizes beneficiaries, with distinct provisions for each: spousal, eligible designated, designated, and non-designated beneficiaries.

Spousal beneficiaries generally have the most flexibility. If you are the deceased parent’s spouse, you typically have three primary choices. You can treat the inherited IRA as your own, transferring assets into your existing IRA or retitling it in your name. This allows for continued tax-deferred growth and defers RMDs until you reach your own RMD age. Alternatively, you can transfer assets to an inherited IRA in your name, maintaining it as a beneficiary account. This allows for distributions based on your life expectancy (or the decedent’s if older) and can be beneficial if you need access to funds before age 59½ without incurring the 10% early withdrawal penalty. A third option is to disclaim the inheritance, passing assets to contingent beneficiaries.

For non-spousal beneficiaries, rules changed with the SECURE Act of 2019 for deaths occurring after December 31, 2019. Most non-spousal beneficiaries fall into two categories: Eligible Designated Beneficiaries (EDBs) or Designated Beneficiaries. EDBs include minor children (until age 21), disabled or chronically ill individuals, or those not more than 10 years younger than the decedent. EDBs can stretch distributions over their own life expectancy, offering extended tax-deferred growth.

Most other non-spousal beneficiaries, such as adult children or grandchildren, are classified as Designated Beneficiaries. For these individuals, the “10-Year Rule” generally applies. This rule mandates that the entire inherited IRA balance must be distributed by the end of the 10th calendar year following the parent’s death. This eliminates the previous “stretch IRA” strategy.

A third, less flexible category is Non-Designated Beneficiaries, typically including entities like the deceased’s estate or a trust that does not qualify for special rules. If the IRA is inherited by an estate, distribution rules generally depend on whether the original owner died before or after their RMD required beginning date, often resulting in a shorter distribution period. Identifying your beneficiary status is paramount, as it establishes the framework for all subsequent decisions.

Navigating Required Distributions

Understanding the rules for taking money out of an inherited IRA is essential to avoid penalties and manage assets effectively. Required Minimum Distributions (RMDs) vary significantly based on your beneficiary status and the original owner’s age at death.

For most non-spousal beneficiaries of IRAs inherited after 2019, the 10-Year Rule applies. This rule requires the entire account to be emptied by December 31 of the 10th year following the parent’s death. If the original owner had started taking RMDs, annual RMDs must be taken within the 10-year period (as clarified by IRS regulations effective 2025). If the owner died before their RMD beginning date, no annual RMDs are required within the 10-year period, but the full balance must still be withdrawn by the end of the 10th year. Failing to take a required distribution can result in a penalty, reduced from 50% to 25% of the amount not withdrawn, and further to 10% if corrected timely.

Eligible Designated Beneficiaries (EDBs) have flexible distribution options. If an EDB chooses to take distributions over their life expectancy, RMDs are calculated using IRS life expectancy tables. These distributions generally begin by December 31 of the year following the original owner’s death. This “stretch” option allows for continued tax-deferred growth over a longer period.

Spousal beneficiaries have unique RMD considerations. If a spouse treats the IRA as their own, standard IRA RMD rules apply, meaning distributions are not required until their own RMD age. If the spouse maintains the IRA as an inherited IRA, RMDs can be based on their life expectancy or the decedent’s, if older. They can also delay RMDs until the year the deceased spouse would have reached their RMD age. If the parent died before taking their RMD for the year, the beneficiary is responsible for taking any remaining RMD.

Understanding Tax Implications

Distributions from an inherited IRA carry important tax implications. The tax treatment largely depends on whether the inherited account was a traditional IRA or a Roth IRA.

Distributions from an inherited traditional IRA are generally taxable as ordinary income to the beneficiary. Withdrawals are added to your other income and taxed at your marginal income tax rate. While taxable, the 10% early withdrawal penalty (typically for traditional IRAs before age 59½) does not apply to inherited IRAs, regardless of the beneficiary’s age. Strategic planning of withdrawals over the allowed distribution period can help manage the tax impact, potentially preventing distributions from pushing you into a higher tax bracket.

In contrast, distributions from an inherited Roth IRA are generally tax-free, provided certain conditions are met. For earnings to be tax-free, the Roth IRA must have been open for at least five years from the original owner’s first contribution. If this five-year holding period has not been met at the owner’s death, the earnings portion of distributions may be taxable until the five-year period is satisfied, though contributions can always be withdrawn tax-free.

While inherited IRA distributions are subject to income tax, the inherited assets themselves are typically not subject to a separate estate tax directly at the beneficiary level. Any federal estate tax, if applicable, is generally levied on the deceased parent’s estate before the assets are distributed. Beneficiaries will receive Form 1099-R from the financial institution annually, reporting the total amount distributed and the taxable portion. This form is essential for accurately reporting the income on your annual tax return.

Establishing the Inherited IRA Account

Once you understand your beneficiary status and the distribution rules, the next step is to establish the inherited IRA account. This process involves specific procedural actions with the financial institution holding the assets.

The inherited IRA account must be properly re-titled to reflect its beneficiary status. This typically involves titling the account to include the deceased owner’s name, indicate it is an inherited IRA, and name the beneficiary. Common titling formats include “Deceased Owner’s Name, Deceased, FBO (For Benefit Of) Beneficiary’s Name” or “Beneficiary’s Name, as Beneficiary of Deceased Owner’s Name IRA.” Maintaining this titling is important for compliance with IRS regulations.

Financial institutions will require specific documentation to process the inheritance and set up the new account. You will typically need a certified copy of the death certificate, identification documents, and completed beneficiary designation forms. If the original IRA was held at a different financial institution, you may need to provide additional paperwork specific to that institution’s transfer process.

The transfer of funds from the deceased’s account to your inherited IRA should generally be done through a direct trustee-to-trustee transfer. This method ensures funds move directly between financial institutions without being distributed to you personally, which avoids potential tax withholding or the risk of a deemed distribution. While spousal beneficiaries may have the option of a 60-day rollover, direct transfers are generally preferred to maintain tax-deferred status and avoid complications. Once the account is established and funded, no additional contributions can be made to an inherited IRA.