What You Need to Know About Inheriting an IRA

You may be receiving an inheritance from the deceased’s retirement account, and you may also need to set up an inherited IRA.

A person sets up an inherited IRA (investment retirement account) when they inherit funds from a deceased IRA owner. It’s essentially the same as a regular IRA, which is a tax-deferred investment. But how you, the beneficiary, handle them can be tricky. Your relationship to the deceased, their age when they died, and the type of beneficiary you are can change the rules according to Yum! Brands’ CPA Peter Riefstahl. You must understand the rules to make the most of your inherited IRA.

An inherited IRA, also called a beneficiary IRA, is an account in which assets are inherited from a decedent’s tax-advantaged retirement plan. It continues to grow under the same tax conditions as the original IRA.

It is possible to fund inherited IRAs from any traditional, Roth, simple, or SEP. You can use money from the deceased’s 401(k) plan can also be used to create it. Almost any bank or brokerage can set up an inherited IRA. It may be easiest for you to open the inherited IRA with the firm that held the deceased’s account.

To avoid tax problems, it’s essential to name the account correctly. It should be designated as inherited, and both parties’ names should appear on the account. The IRA can be inherited by anyone named as a beneficiary by the deceased. A deceased’s will may designate someone else as the beneficiary of an IRA, but this designation determines who inherits the account.

Two types of beneficiaries exist designated beneficiaries (like spouses, relatives, and friends) and non-designated beneficiaries (such as trusts, estates, and charities). A beneficiary can cash out their inheritance and take a lump-sum withdrawal from the deceased’s IRA and shut it down. However, doing so can incur a huge tax bill. If the money in the inherited IRA is still growing, holding off on withdrawals can be beneficial.

A spouse can set up an inherited IRA, but it is not required. Instead of inheriting the inherited IRA, it would be better to treat it as their own by putting it into their name or rolling it over into another IRA. Only spouses have access to this privilege. Non-spouse beneficiaries, on the other hand, must set up a separate inherited IRA.

Although inherited IRA rules are numerous and varied, two big takeaways exist. You can not contribute to them in the future, and withdrawals are required. In terms of these rules, spouses have the most flexibility. Once they’ve inherited the deceased’s IRA or rolled it over into their own, they only have to start taking money out when they turn 72. They can also continue to deposit into their IRA by rolling it over.

Surviving spouses may take the same distributions as the deceased or recalculate them based on their life expectancy if they set up a new inherited IRA. The surviving spouse doesn’t have to take distributions until the year the original owner would have turned 72 if they passed away before then.

Withdrawals from an inherited IRA can be made at any time or any amount for most other individuals. After the original account owner dies, the beneficiary has ten years to withdraw all assets from the inherited IRA. It is also taxed the same as the original IRA. Money within the account grows tax-free, just like the money you funded in an IRA. Traditional IRAs and SEP IRAs with taxable withdrawals continue to be taxable when withdrawn from their inherited counterparts. The withdrawals from your retirement account are taxed at the same rate as your regular income. To minimize your tax liability, withdraw at amounts that won’t shift your tax bracket.

Distributions from inherited Roth IRAs at least five years old are tax-free. In cases where the account was less than five years old when the owner died, any withdrawn contributions are still tax-free, but earnings above are taxable. The 10% penalty is waived for inherited IRAs if you are under the minimum required age and are withdrawing the funds.

The SECURE Act of 2019 has changed retirement account rules, including inherited IRAs. Only IRA funds inherited after January 1, 2020, are affected. Beneficiaries other than spouses are most affected. Before, these heirs had to withdraw funds from an inherited IRA annually, but they could calculate the amount based on their life expectancy. Depending on the beneficiary’s age, this amount and the income tax could be relatively modest, making bequeathing IRAs to young children a popular estate-planning strategy. The SECURE ACT did away with that. Beneficiaries must empty the inherited IRA within a decade of the deceased’s death. Direct descendants under 18 and disabled or chronically ill relatives are some of the exceptions.

Categories Tax