If you’re a named beneficiary of an IRA account whose owner recently passed away, you may feel overwhelmed and unsure how to proceed. Inherited IRA assets are subject to myriad IRS and federal regulations, several of which were revised under the recently-passed SECURE Act, creating even more confusion. As a beneficiary, understanding your options, obligations, and potential tax consequences is critical to maximizing the value of your inheritance.
The Good News
An inherited IRA is one of the more streamlined ways for heirs to receive property, in that the assets are considered outside of the decedent’s estate. They flow directly to the named beneficiaries without first having to go through probate (a time-consuming, public, and sometimes costly process). Even better, if you’re the beneficiary of a Roth IRA account, you’ll also avoid paying taxes on your inheritance.
What Do I Need to Know?
The options for inheriting IRA assets and the tax implications thereof depend on a few factors:
- The beneficiary’s relationship to the deceased (Spouse vs. Non-Spouse)
- The age of the account owner at death (and date of death)
- The type of IRA account inherited (Traditional/Rollover vs. Roth)
A surviving spouse generally has the most flexibility in claiming inherited IRA assets. There are three basic options:
Option #1: Lump Sum Distribution
The first option is to remove the money from the account and take a lump sum taxable distribution. This is probably the least tax-efficient option, particularly for large IRA accounts or beneficiaries who are already in a high-income tax bracket. However, the usual 10% early withdrawal penalty is waived for beneficiaries younger than 59 ½.
Option #2: Spousal Rollover
Alternatively, a surviving spouse can transfer the inherited assets to an IRA account in their own name. This is a popular choice, particularly if the surviving spouse has already reached age 59 ½ (and is no longer subject to a 10% early withdrawal penalty). The inherited assets are then considered part of the IRA of the surviving spouse, and not subject to Required Minimum Distributions until the surviving spouse reaches age 72 ½ . In many cases, this significantly extends the tenure of tax-deferred growth for the inheritance.
Option #3: Open an Inherited IRA Account
A final option is for the surviving spouse to keep the inherited assets in the name of the original account owner and draw on them as a beneficiary. Similar to the lump sum (option 1), this option waives the 10% early withdrawal penalty. However, it also obligates the surviving spouse to commence Required Minimum Distributions (RMD), potentially sooner than would have been required under the spousal rollover scenario (option 2). The inherited IRA is therefore a good choice for a surviving spouse who is younger than 59.5 and might need to access some of their inheritance right away--but wants the option to keep most of it growing tax deferred.
Non-spousal beneficiaries have only two options; the “lump sum” taxable distribution or an Inherited IRA account. However, per the terms of the 2019 SECURE Act, non-spousal Inherited IRAs established after January 1, 2020, must be completely distributed within 10 years of the original account owner’s death. There are a few situations in which this new “10-year rule” can be waived, including for beneficiaries who are:
- Disabled or chronically ill
- Minor children of the decedent
- Less than 10 years younger than the decedent
Nevertheless, the SECURE Act’s “10-year rule” curtails the ability of non-spouse beneficiaries to tax-efficiently “stretch” their payments over time, compared to rules that were in effect prior to January 1, 2020. Among other things, the change reduces the cumulative tax benefits for younger beneficiaries of traditional or rollover IRAs—and may lead some investors to reconsider the role for these types of accounts in their estate plan.
 For IRA assets inherited after January 1, 2020
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