An inherited IRA is an account opened to distribute the assets of a deceased owner of an individual retirement account (IRA) or employer-sponsored plan to the beneficiary or beneficiaries. What can or cannot be done with an inherited IRA and how distributions from the account are made both depend on who the beneficiary is (or beneficiaries are).
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Marguerita M. Cheng, CFP®, CRPC®, RICP®
Chief Executive Officer of Blue Ocean Global Wealth
Marguerita M. Cheng, CFP®, CRPC®, RICP®, is the chief executive officer at Blue Ocean Global Wealth. As a Certified Financial Planner Board of Standards Ambassador, Marguerita educates the public, policymakers and media about the benefits of competent and ethical financial planning. She is a past spokesperson for the AARP Financial Freedom campaign.Read More
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Thomas J. Brock, CFA®, CPA
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- Updated: September 6, 2022
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Though the purpose of an IRA is to save enough money for the time between retirement and death, many people will die before they have had the chance to exhaust the balance of the account. But what happens to those balances after death?
The IRS ensures that IRA holders and holders of employer-sponsored plans can pass on their retirement assets to their loved ones through inherited IRAs.
What Happens to Your IRA When You Die?
Typically, every IRA — and even employer-sponsored plans like the 401(k) — has a designated beneficiary or a list of beneficiaries that will inherit the IRA once the account holder has died.
This designation of a beneficiary (or beneficiaries) ensures that no matter what happens to the account holder, the assets they have for retirement can be used by the people that are important to them.
These inherited assets are generally transferred to an inherited IRA, from where they will be distributed depending on who the beneficiary is (or beneficiaries are).
Beneficiaries can be the account holder’s spouse, children, other family members, friends, a trust or an estate, among other options.
How Do Inherited IRAs Work?
Broadly considered, there are two types of beneficiaries of the IRA of a deceased: the spouse of the deceased and everyone else. What happens to your IRA when you die depends largely on whether or not your beneficiary is a spouse.
Inherited IRA Rules for Spouses
If your spouse is the beneficiary of your IRA, they can take over the account in one of three ways:
- The spouse can designate themselves as the owner of the decedent's IRA. This is a change of ownership of the existing IRA.
- The spouse can roll over the IRA of the deceased — or their part of it, if there are multiple beneficiaries — into their own existing IRA or a new IRA that they have created for that purpose. The two IRAs (the decedent's and the spouse's) must be the same type: traditional to traditional or Roth to Roth.
- The spouse can be a beneficiary instead of an owner by creating an inherited IRA to make distributions.
- If the deceased spouse had started making required minimum distributions (RMDs) in a traditional IRA, the spouse can choose to distribute the assets in the IRA with the schedule the deceased was using or create a new distribution or withdrawal schedule based on their own life expectancy.
- If the deceased had not yet made RMD in the year of death, the spouse will make it for that year based on the decedent’s schedule and only change to a new schedule in the following year.
- If the deceased had not started making RMD on a traditional IRA, the spouse can start it (on their own life expectancy) as early as Dec. 31 of the year after the year of death or as late as the end of the year the original owner would have turned 72. For example, if the deceased died in 2021 at age 60, the spouse can decide to start RMD the year after (2022) or wait until when the deceased would have been 72 (2033).
- If the account is a Roth IRA, there are no RMDs, but the spouse can make voluntary distributions. Even if these distributions are made before age 59 1/2, the standard 10% penalty for early withdrawals doesn't apply.
- For both traditional and Roth IRAs, the spouse can begin making voluntary distributions (based on their own life expectancy) without penalty as soon as they are 59 1/2 years old. The IRS will penalize withdrawals before then, unlike the case with Roth IRAs in option 3.
- If it’s a traditional IRA, RMDs will set in when the spouse turns 72 rather than when the deceased spouse would have turned 72. Such RMDs will be made based on the life expectancy of the spouse.
- For Roth IRAs, there is no RMD. In other words, the IRS considers funds invested in Roth IRA from a spouse as yours.
In essence, the inherited assets in the decedent’s IRA will be treated as if the spouse (rather than the deceased) had owned them from the very beginning.
Inherited IRA Rules for Non-Spouse
Having considered the inherited IRA distribution rules for spouses, let’s now focus on the rules for non-spouse beneficiaries.
- No rollover or additional contributions are allowed. An inherited IRA is set up solely for the distribution of the assets.
- For accounts inherited after December 31, 2019, all the assets in the inherited IRA must be fully distributed within 10 years from the death of the original owner, whether they are traditional or Roth IRA. Even Roth IRAs have required distributions and all the money must be distributed within 10 years.
However, certain sets of non-spousal beneficiaries are given more freedom than the rest. These are minor children of the deceased (nevertheless, once they reach the majority age, they will be treated like other non-spousal beneficiaries and they must empty accounts within 10 years of the decedent’s death), disabled or chronically ill beneficiaries and beneficiaries who are not more than 10 years younger than the deceased.
For these three classes, other rules apply. If it’s a traditional IRA, they can calculate their RMD based on their life expectancy rather than the decedent’s. If it’s a Roth IRA, there are no RMDs.
Simply put, non-spousal beneficiaries don’t have the options of owning the decedent’s IRA or rolling it over that the spouse has.
What Are Your Payment Options?
Whether you are a spousal or a non-spousal inherited IRA beneficiary, you have two payment options. With a lump-sum payment, you can opt to distribute all the assets at once. Alternatively, you can take gradual payments.
The spouse of the deceased, minor children, disabled or chronically ill beneficiaries and those who are not more than 10 years younger than the deceased can make RMDs based on their own life expectancy in an inherited traditional IRA (in addition to voluntary distributions above the RMD) as well as entirely voluntary distributions in an inherited Roth IRA.
Other beneficiaries must distribute everything within 10 years.
Whether lump-sum or gradual, beneficiaries must distribute the money inside an inherited IRA. Failure to do so can result in a 50% penalty — that is, you’ll lose half of the money you were supposed to take out.
Both the spouse and non-spouse beneficiaries can disclaim the IRA and refuse to inherit the assets. In this case, the IRA will pass to the next eligible beneficiary.
How Does the SECURE Act Impact Inherited IRAs?
Before the SECURE Act of 2019, all beneficiaries of an inherited traditional IRA could distribute the assets based on their own life expectancy. They could also make entirely voluntary distributions in an inherited Roth IRA. The only limitation for non-spousal beneficiaries (compared to spousal beneficiaries) was that they couldn’t take ownership or roll over the decedent’s IRA.
However, the SECURE Act requires that non-spousal beneficiaries (except the three exempted categories) who inherited accounts after December 31, 2019, must distribute all the assets within 10 years whether it’s a traditional or Roth IRA.
What Are the Tax Implications of An Inherited IRA?
The tax implications of an inherited IRA depend on whether the account is a traditional IRA or a Roth IRA.
For an inherited traditional IRA, any withdrawals — lump-sum or gradual, required or voluntary (above the RMD) — are taxed at ordinary income rates.
However, for an inherited Roth IRA, contributions into the account can be distributed tax-free. Earnings — the extra interest generated through investments — in the account can also be withdrawn tax-free, provided the original owner had owned the account for at least five years.
Similarly, if the spouse takes ownership or rolls over the Roth IRA of the deceased, they can make tax-free and penalty-free distributions at the fifth year of ownership — provided they are at least 59 1/2 years old.
Inherited IRAs can be very complicated to decipher. Consequently, it is crucial to speak to your financial advisor before you make any single decision. Your financial advisor will help evaluate your options and determine the most appropriate distribution option for your personal and financial circumstances.
3 Cited Research Articles
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- Congress.gov. (2019). 116th Congress (2019-2020): Setting Every Community Up for Retirement Enhancement Act of 2019. Retrieved from https://www.congress.gov/bill/116th-congress/house-bill/1994/text
- U.S. Internal Revenue Service. (2022, May 2). Publication 590-B (2021), Distributions from Individual Retirement Arrangements (IRAs). Retrieved from https://www.irs.gov/publications/p590b#en_US_2019_publink1000231236
- U.S. Internal Revenue Service. (2021, September 27). Retirement Topics - Beneficiary. Retrieved from https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-beneficiary