An Inherited IRA is an account structure that allows a beneficiary to manage an inheritance that was passed down to them through an IRA or 401(k) account.
If you’ve inherited an IRA as a beneficiary, it’s up to you to figure out how to manage and make the most of the account.
You may be wondering when and how can you take a distribution of the assets within the account, your options for rolling over the account and more.
There are many unique IRS rules regarding Inherited IRAs that every beneficiary should know. Some of these rules apply to your distribution options, while others are dependent on your relationship to the benefactor; such as whether you’re a spouse.
Knowing these rules may help you design an informed investment and distribution strategy for the account.
Here are 5 things every Inherited IRA owner needs to know about their account.
1. Inherited IRA Account Structure
When you inherit an IRA, the account maintains the same tax structure and advantages of the original account as it was created by the benefactor.
This could mean the account maintains a post-tax structure, such as a Roth IRA, or a pre-tax structure, such as a Traditional IRA, Solo 401(k) and more.
2. Are You a Spouse or Non-Spouse?
Your relationship to the benefactor makes a difference in how you can manage and take distributions from your Inherited IRA.
If you are the spouse of the original account holder, then your Inherited IRA can be treated like a regular Roth or Traditional IRA, without any unique distribution or contribution rules. You essentially takeover the IRA as your own.
You also have the opportunity if you are a spouse under the normal retirement age of 59 ½ to elect to treat the account as inherited. This would allow you to take distributions from the account without the 10% penalty for early withdrawal.
However, if you’re a “non-spouse,” to the benefactor, then you can’t contribute any money into the Inherited IRA, and there are special distribution rules for the account.
3. Taking Distributions as a Non-Spouse
As a non-spousal inheritor of IRA, you must distribute the full account within 10 years from the death of the original account holder. This is a new rule effective beginning December 31st, 2019 based on the 2019 SECURE Act.
Certain account beneficiaries are exempted from this 10-year rule, and can draw down the account with required minimum distributions calculated over their life expectancy. These beneficiaries include:
- Disabled beneficiaries (as defined in IRC Section 72(m)(7))
- Chronically Ill beneficiaries (as defined in IRC Section 7702B(c)(2))
- Individuals not more than 10 years younger than the decedent
- Certain minor children of the original account owner, but only until they reach the age of majority
When you take a distribution from an Inherited Roth IRA, then the money within the account was contributed post-tax, and you don’t have to worry about paying taxes on any distributions from the account.
When you take distributions from a tax-deferred IRA such as a Traditional or SEP, then you will pay taxes on the amount distributed as regular income.
4. Taking Distributions as a Spouse
If you are the spouse of the original account owner, your distribution options for your Inherited IRA differ slightly from the non-spousal options.
As the beneficiary of an Inherited Roth IRA, you have 3 distribution options for your account:
- You can treat the Inherited IRA as your own by re-titling the account in your own name — which is only allowed if you’re the sole beneficiary. Or you can rollover/transfer the funds into your own IRA account.
- You can take “lifetime distributions” from you Inherited IRA, where you make your distributions payable over the life or life expectancy of the designated beneficiary. (However, you must take distributions by December 31st of whichever comes last: the year your spouse would have attained age 70 ½; or the year after your spouse passed.)
- You can distribute the account in full over a 10-year time span. There are no annual distributions required, as long as the account is emptied by the end of the 10th calendar year after the year of the original account owner’s death
5. You Can Self-Direct an Inherited IRA
If you’re a spouse to the original account owner of your Inherited IRA, you can self-direct your account using a self-directed IRA account provider.
There are many different distribution strategies afforded to both spousal and non-spousal Inherited IRA owners.
Choosing which strategy is best for your account depends on your individual investment goals, and the rules that govern your account type and distribution options.
This article has been updated to reflect tax code changes in the 2019 Secure Act.
Safeguard Advisors, LLC is not an investment advisor or provider, and does not recommend any specific investment.
We provide properly structured self-directed retirement plan platforms that provide you as the investor with full control over investment decisions.
The information above is educational in nature, and is not intended to be, nor should it be construed as providing tax, legal or investment advice.