Congratulations! You’ve inherited a tax-advantaged retirement account. Now that you own the account’s value, certain rules apply depending on your relationship with the former owner. Whether you have inherited an employee-spored retirement account like the 401(k) or any form of Individual Retirement Account (IRA) — Roth, SEP, or SIMPLE IRAs — you must abide by the prerequisites or incur significant penalties.
While managing your existing retirement account may be complex, an inherited IRA sets the bar for complications. The only straightforward rule is the income tax treatment of the original tax-advantaged account remains unchanged. As a beneficiary, it’s crucial to understand the steps involved in obtaining and running an inherited IRA to avoid costly mistakes.
Understanding Inherited IRAs
Spouses have the most flexibility when inheriting an IRA. They can treat the inherited IRA as their own, which means they can:
- Name their own beneficiaries: This allows them to designate who will inherit the IRA after they pass away.
- Follow standard RMD rules: Spouses can delay taking withdrawals until they reach the required minimum distribution (RMD) starting age, which is currently 73 (gradually increasing to 75 by 2030). They can also continue with RMDs if they began for the original owner within the last ten years.
In essence, inheriting an IRA as a spouse gives you more control and aligns the handling of the IRA with your own retirement plans.
Spouses also have the liberty to let the funds remain in the inherited account until they are at the RMD starting age. Additionally, they can roll over the account into a Roth IRA, qualified employee-sponsored plan, or 403(b) plan or become the account’s beneficiary. The IRS provides additional rules on running the Roth IRA account where rules differ.
Non-spouses don’t have the same leeway as spouses. They cannot own the inherited account, make contributions, or transfer funds to their IRA account. The rules require them to roll over the inherited IRA account into a beneficiary IRA and cash out within ten years. Immediate descendants who are minors must cash out in 10 years once they are of legal age.
What to Do When You Inherit an IRA (Spouse Beneficiary)
Consolidation Option
As a spouse, you can consolidate the inherited IRA into your existing IRA to simplify management. The rules of your current account will continue to apply after the consolidation.
RMD Considerations
You own the inherited account. Therefore, you can make contributions and receive RMDs when you reach the RMD starting age or continue with the RMDs.
Tax Implications
Tax treatment on the distributions depends on the type of inherited IRA account or rollover account. RMDs get taxed as income if the account acquires funds with pre-tax dollars like the traditional IRA or 401(k). Distributions are tax-exempt if funds come from post-tax dollars like the Roth IRA, but earnings from the distributions get taxed as income.
What to Do When You Inherit an IRA (Non-Spouse Beneficiary)
Required Distribution Options
- Non-spouse beneficiaries can receive RMDs at any time if the original account owner was over 59.5 years old.
- Funds in the account must be distributed within ten years after inheritance if the original owner was under 59.5 years old, except for beneficiaries who are disabled, critically ill, or minor children.
- Non-spouses must roll over an inherited IRA immediately upon inheritance into a beneficiary IRA and receive distributions within ten years.
Important Considerations for All Beneficiaries
- Find the IRA Custodian. Avoid doing anything with the inherited IRA until you can locate the financial institution holding the account.
- Seek Professional Guidance. Consult a financial advisor to understand the tax implications of the inherited account and develop a distribution strategy with the most tax advantages.
- Beware of Scams targeting IRA beneficiaries, from government imposters to tech support frauds.
Making the Most of Your Inherited IRA
- You can enjoy tax-deferred growth by spreading out distributions within the ten permitted years, allowing the remaining funds to continue growing tax-deferred.
- Name beneficiaries for the inherited IRA if the terms of the account permit it for easy wealth transfer.
Familiarize Yourself with Inherited IRA Rules
Handling inherited IRAs is intricate, requiring knowledge to avoid breaking IRA rules and facing penalties. Seek professional guidance for tailored advice before handling any funds in the account. With proper management, an inherited IRA can grow your funds tax-deferred, supply continuous income for up to ten years, provide an inheritance for your beneficiaries, or afford you tax-free income if you convert it into a Roth IRA.
Representatives do not provide tax and/or legal advice. Any discussion of taxes is for general informational purposes only, does not purport to be complete or cover every situation, and should not be construed as legal, tax or accounting advice.  Clients should confer with their qualified legal, tax and accounting advisors as appropriate.Â
