Inherited IRA

Inherited IRA

An inherited IRA (also called a beneficiary IRA) is an individual retirement account established for someone who inherits IRA assets after the original account owner dies. Rules for inherited IRAs depend on the beneficiary’s relationship to the decedent, the type of IRA (traditional vs. Roth), and the date of death relative to the SECURE Act changes.

How inherited IRAs work

• The deceased’s IRA assets are moved into a designated inherited IRA in the beneficiary’s name (unless the beneficiary takes a lump-sum distribution).
• You cannot make new contributions to an inherited IRA.
• Tax reporting for distributions typically uses Form 1099‑R; custodians report account balances on Form 5498.
• Tax treatment of withdrawals follows the type of IRA:
• Traditional IRA: distributions are generally taxable as ordinary income.
• Roth IRA: distributions are generally tax-free to the beneficiary (provided the Roth met the five‑taxable‑year rule), and there is no early‑withdrawal penalty.

Key law change to know: the SECURE Act

The SECURE Act (effective for deaths after Dec. 31, 2019) removed the long‑used “stretch” rules for many non‑spouse beneficiaries. Most non‑spouse beneficiaries must now fully distribute inherited IRAs within 10 years of the owner’s death. Certain beneficiaries are exempt from the 10‑year rule (see “Exceptions” below).

Spousal beneficiaries: greater flexibility

Spouses have the most options:
* Treat the account as their own by rolling the assets into their own IRA — this allows deferral of required minimum distributions (RMDs) until the spouse reaches the applicable RMD age (under current law, many beneficiaries can defer until age 73).
* Keep the account as an inherited IRA — if the decedent was already taking RMDs, the spouse must continue distributions (or adopt a schedule based on life expectancy); if the decedent hadn’t reached the RMD start date, different timing rules may apply.
* Take a lump-sum distribution (taxable if from a traditional IRA).
* Disclaim the inheritance (pass it to contingent beneficiaries or the estate).

Spouses have 60 days to roll a distributed amount into their own IRA if the distribution is not an RMD.

Non‑spouse beneficiaries: limited options and the 10‑year rule

Non‑spouse individuals and entities cannot treat an inherited IRA as their own (no contribution/transfer into a personal IRA). Typical options:
* Open an inherited IRA in the beneficiary’s name and take distributions according to applicable rules.
* Take a lump-sum distribution (taxable if from a traditional IRA).
* Disclaim the inheritance.

Distribution rules:
* If the owner died before Jan. 1, 2020: many beneficiaries could take RMDs based on their life expectancy (the “stretch” method).
* If the owner died on or after Jan. 1, 2020: most non‑spouse beneficiaries must withdraw the full balance within 10 years of death (the SECURE Act 10‑year rule).

Exceptions (eligible designated beneficiaries):
The 10‑year rule does not apply to these beneficiaries; instead, they may use life‑expectancy based distributions:
* Surviving spouse
* Minor child of the decedent (until reaching the age of majority; then the 10‑year rule applies)
* Disabled individual
* Chronically ill individual
* Individual who is not more than 10 years younger than the decedent

Trusts, charities, and estates are treated differently; consult custodians and advisors for trust-specific rules.

Tax considerations and common questions

• Are inherited IRAs taxable? Traditional IRA withdrawals are generally taxable when distributed; Roth IRA withdrawals are typically tax‑free for beneficiaries (subject to Roth holding-period rules). Estate tax treatment is separate from income tax treatment.
• What if a minor inherits an IRA? A custodian may manage the account until the child reaches the state’s age of majority; once they reach majority, the applicable distribution rules apply.
• How can taxes be minimized? Planning steps before death can help:
• Converting a traditional IRA to a Roth IRA (pay the tax now to potentially avoid income tax for beneficiaries).
• Reviewing and updating beneficiary designations.
• Consulting a financial or tax advisor for estate and income‑tax strategies.

Practical steps if you inherit an IRA

1. Notify the IRA custodian and request beneficiary‑specific paperwork.
2. Decide whether to treat the account as inherited (and open an inherited IRA) or — if you are a spouse — roll it into your own IRA.
3. Understand which distribution rules apply (pre‑ or post‑SECURE Act, and whether you qualify as an eligible designated beneficiary).
4. Plan distributions to manage tax impact; consult a tax professional.

Key takeaways

• An inherited IRA must be managed under specific IRS rules that vary by beneficiary type and the date of the owner’s death.
• Spouses can generally roll inherited IRAs into their own accounts and defer RMDs; non‑spouse beneficiaries usually must empty the account within 10 years under the SECURE Act.
• Traditional IRAs produce taxable distributions; Roth IRAs are typically tax‑free to beneficiaries.
• Because rules are complex and consequences significant, seek professional tax or financial advice when you inherit an IRA.