You’ve Inherited an IRA. Now What?
If you’ve been named a beneficiary or inherited an IRA, you’re likely facing some tough questions — what are the next steps, and what happens now? Governing bodies like the IRS and recent legislation such as the SECURE Act have outlined important rules regarding an inherited IRA, such as how much you may owe in taxes as well as whether you will need to begin taking required minimum distributions. These can depend on several factors, such as your relationship to the deceased, whether the IRA inherited is Roth or traditional, and more.
When a transition such as this takes place, especially when it happens suddenly or unexpectedly, you’re more than likely not focused on taxes or laws. But receiving your inherited IRA in a tax-efficient and meaningful way can depend on making well-informed decisions and working with a trusted financial professional.
Alternatively, making uninformed choices regarding your inherited IRA could cost you a portion of your inheritance in taxes or IRS penalties. In circumstances such as these, it is critical to understand the rules surrounding an inherited IRA.
Those who inherit IRAs often have questions pertaining to how and when they’re able to withdraw money from the account involved. IRS rules regarding distributions take into account a number of factors including age and account type.
A factor that influences required minimum distribution (RMD) payments, potential penalties, and other details of inherited IRAs is age. For instance, if the account holder died before or after the age of 72 in 2022 (at which time the IRS requires you to take minimum withdrawals from a traditional IRA) there are implications involved for beneficiaries of inherited IRAs. The age of 59½ is also important, especially for surviving spouses who decide to transfer the account balance into their own IRA accounts and subsequently withdraw the funds.
Whether you inherit a traditional or Roth IRA is another deciding factor that influences distribution details. With an inherited IRA, you are required to withdraw the entirety of the account within 10 years, if you are a non-spousal beneficiary, according to the SECURE Act passed in December 2019. If you inherit a Roth IRA, you don’t pay taxes on distributions, but if you inherit a traditional IRA, you’ll generally pay taxes on the distributions you take in excess of the deceased account holder’s basis. This will depend on whether the deceased’s contributions were deductible or non-deductible.
Spouse Beneficiary of an IRA
If you are the surviving spouse you will be faced with three options when inheriting an IRA.
The first option is to remove the money from the account and spend or invest it as you see fit. Depending on the size of the account, inherits going this route may possibly incur some steep penalties from the IRS.
Alternatively, you may consider remaining the beneficiary of the existing IRA or transferring the assets to a retirement account under your name. This is often seen as a simpler option, so many people choose to move the inherited amount into an IRA in their own name. If you’re interested in combining these assets with an existing retirement account, you may have the funds transferred. It is important to note that if you transfer any distributed money to a new account in your name, you must do so within 60 days. This will allow you to avoid taxation on any withdrawals, allowing the amount to continue to grow tax-deferred.
It may also make sense to leave the inherited money in the original account and use the funds as needed as a beneficiary. For example, when you are under 59½ years old and transfer the inherited IRA to your own retirement account, you will not be able to access the money without a penalty. Until you reach 59½, the withdrawals will be taxable and will also incur an additional 10% IRS penalty.
Non-Spousal Beneficiary of an IRA
When you are inheriting an IRA from someone other than your spouse, the details typically become more complicated. Unlike an IRA that is inherited from a spouse, you will not be able to move this money into your own retirement account. In order to keep the tax benefits of the account, you will need to set up a new Inherited IRA for Benefit of your name. Once the account is created, you may transfer assets from the original account to your beneficiary IRA. While this may seem confusing, a trusted financial advisor can guide you through the process.
It is also important to note that you will not be able to make new contributions to an Inherited IRA. Regardless of your age, you will need to begin taking required minimum distribution payments from the new account by December 31st of the year following the original owner’s death.
With the SECURE Act passing, non-spousal beneficiaries are now required to withdraw the entirety of the account within a 10-year period if the deceased passed on or after January 1, 2020. This can create a significant difference in your future tax obligations, as previous law allowed for the IRA amount to be withdrawn over the beneficiary’s remaining life expectancy. Exceptions to this new law include those who are:
Disabled or chronically ill, Minors, Less than 10 years of age younger than the deceased
Whether you’re a spouse or non-spouse beneficiary inheriting an IRA, there are a few key details to keep in mind. In any of these instances, the IRS does not allow you to transfer the money from an inherited IRA into an existing account of yours. Instead, you will have to transfer your portion of the assets into a new IRA that is set up and formally named as an inherited IRA. Additionally, no contributions are allowed in the new, inherited IRA account.
Familiarizing yourself with these changes in legislature and tax obligations of inheriting an IRA now can help you and your loved ones better prepare to receive your inheritance. If you find yourself wondering if you’re making the most effective decision for you and your family, you may want to work with a trusted financial professional who is familiar with the tax obligation and changing regulations regarding the inheritance of an IRA.
*This article was written prior to the most recent legislature, the SECURE Act 2.0, and some rules may have changed. Please contact us or your qualified advisor if you have any questions about your individual situation.
Matt Ward is a financial advisor and the president of New Century Investments, an independent investment advisory firm serving business owners, pre-retirees, and retirees in the Dallas-Fort Worth area and beyond. Matt is passionate about integrating investing, planning, and tax management into a holistic approach. Matt’s breadth of knowledge and experience in both taxes and investment management sets him apart, giving him the ability to design, advise on, and manage business strategies, tax efficiency, and retirement planning. He is known for his care and attention to detail and works hard to develop personal relationships with each of his clients so they can benefit from his customized service and guidance. He loves walking with his clients through their financial journey, supporting them and celebrating with them as they reach their goals.
Matt graduated from Texas Tech University with a bachelor’s degree and is a certified financial planner™ and chartered retirement planning counselor℠ professional. When he’s not working, you can find Matt hiking, playing the guitar, and spending time with his family. To learn more about Matt, connect with us today!