IRS Guidance on Inherited IRAs has evolved since this post was written. Please see OUR MORE recent post for updated information.
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
We can help you sort out the options for your particular situation.
Book a Free Consultation Today:
One of Bristlecone Value Partners’ principles is to communicate frequently, openly and honestly. We believe that our clients benefit from understanding our investment philosophy and process. Our views and opinions regarding investment prospects are "forward looking statements," which may or may not be accurate over the long term. While we believe we have a reasonable basis for our appraisals, and we have confidence in our opinions, actual results may differ materially from those we anticipate. Information provided in this blog should not be considered as a recommendation to purchase or sell any particular security. You can identify forward looking statements by words like "believe," "expect," "anticipate," or similar expressions when discussing particular portfolio holdings. We cannot assure future results and achievements. You should not place undue reliance on forward looking statements, which speak only as of the date of the blog entry. We disclaim any obligation to update or alter any forward-looking statements, whether as a result of new information, future events, or otherwise. Our comments are intended to reflect trading activity in a mature, unrestricted portfolio and might not be representative of actual activity in all portfolios. Portfolio holdings are subject to change without notice. Current and future performance may be lower or higher than the performance quoted in this blog.
References to indexes and benchmarks are hypothetical illustrations of aggregate returns and do not reflect the performance of any actual investment. Investors cannot invest in an index and returns do not reflect the deduction of advisory fees or other trading expenses. There can be no assurance that current investments will be profitable. Actual realized returns will depend on, among other factors, the value of assets and market conditions at the time of disposition, any related transaction costs, and the timing of the purchase.
Economic factors, market conditions, and investment strategies will affect the performance of any portfolio and there can be no assurance that a portfolio will match or outperform any particular index or benchmark. Past Performance is not indicative of future results. All investment strategies have the potential for profit or loss; changes in investment strategies, contributions or withdrawals may materially alter the performance and results of a portfolio. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be suitable or profitable for a client's investment portfolio.
This content is developed from sources believed to be providing accurate information, and it may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.