Updated on March 22, 2024
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Sometimes, the greatest gifts we can give to our loved ones are those they receive after we pass on. Inherited IRAs allow a new IRA account holder to take charge of retirement accounts that have been passed down to them by someone who has died, also known as a benefactor. The beneficiary or heir opens a new account called an inherited IRA, sometimes referred to as a beneficiary IRA, to hold the inherited funds.
Typically, someone might inherit an IRA from a parent or spouse, but you can leave an IRA to just about anyone, including other relatives or even friends. However, there are important inherited IRA rules to understand, including key differences between spousal and non-spousal inherited IRAs.
Below, we’ll walk through what inherited IRAs are, their various types, the rules and tax implications, and more.
IRA stands for individual retirement account. An inherited IRA is a special IRA opened to hold funds passed down from an IRA or an employer-sponsored retirement plan, like a 401(k).
Like other IRAs, inherited IRAs can either be traditional (taxed at the time of withdrawal) or Roth (taxed at the time contributions are made). The new account retains the investments and tax structure of the original IRA.
If you inherit an IRA from someone who died in 2020 or later, the account is subject to new distribution rules under the SECURE Act of 2019. But if you inherited the funds from someone who died in 2019 or earlier, the pre-SECURE Act rules apply.
Under the SECURE Act new rules that apply if the benefactor died in 2020 or later:
Note that RMDs apply to all inherited IRAs, even if the original IRA had a Roth tax structure. Unlike traditional IRAs, Roth accounts don’t have RMDs during the original account holder’s lifetime.
If you inherited an IRA from a non-spouse who died prior to 2020, the old rules apply. You can take RMDs based on your life expectancy, or you can withdraw the entire balance within five years.
Regardless of when the account owner died, inherited IRA beneficiaries have some special privileges that don’t apply to original account holders. For example, you can take a lump sum distribution immediately from an inherited IRA, regardless of your age, without facing an early withdrawal penalty.
Otherwise, so long as you follow the appropriate RMD schedule and the 10-year rule as required, an inherited IRA essentially works like a continuation of the deceased person’s IRA, accruing tax-deferred earnings over time. However, the new account holder cannot make additional contributions to an inherited IRA.
Inherited IRAs are often held at brokerage firms, which, unlike most legitimate banks, don’t carry FDIC coverage. However, they are covered by SIPC insurance, which plays a similar role, offering financial protection to customers in case the brokerage firm fails.
As always, investing comes with some risk. Over time, though, the stock market has trended steadily upward over history, even in the wake of major setbacks like the Great Depression. Returns will vary based on the performance of the account’s investments, but an IRA’s tax advantages make it a popular way to save for retirement.
There are plenty of different types of accounts for retirements out there, which means there are plenty of different types of IRAs that you can inherit.
For starters, you could inherit either a Roth IRA or traditional IRA. You’d then open a Roth or traditional beneficiary IRA to receive the funds — whichever matches the original IRA’s tax structure.
You can even inherit funds from employer-sponsored retirement plans like a 401(k), or SIMPLE or SEP IRAs. The latter two are popular with small business owners and individual contractors. However, in all cases, the funds will be rolled into an inherited IRA with either a traditional or Roth tax structure.
Again, the rules can differ when the original account is an employer-sponsored plan rather than a regular IRA. Specifics can differ by plan, whether the inheritor is the original IRA owner’s spouse, and when the original owner died. If you have questions about what’s required under your specific circumstances, a qualified tax professional can help you.
IRAs and other retirement accounts, like 401(k)s, can be inherited by just about anyone, but beneficiaries often include spouses and children. You can even name a third party, like a trust, as the beneficiary. An IRA can be inherited by a sole beneficiary or by multiple non-spousal beneficiaries.
In general, though, the rules differ based primarily on whether the inherited IRA beneficiary is the original account holder’s spouse. Spouses have more options when it comes to how to treat their inherited IRA funds. For example, a spouse can roll inherited IRA funds over into their own IRA, whereas non-spouses usually can’t do so.
The IRS also has a special category of IRA beneficiaries who have special privileges. They’re known as eligible designated beneficiaries. To qualify as one, you must be:
Eligible designated beneficiaries are allowed options other non-spousal IRA inheritors are not. For example, if you’re an eligible designated beneficiary, you may be able to take RMDs on the inherited account according to your own life expectancy rather than the original account holder’s.
Surviving spouses have the most leeway in deciding what to do with their inherited IRA funds. For instance, unlike non-spousal beneficiaries or even most eligible designated beneficiaries, if you’re a spousal beneficiary, you can roll over the inherited funds into your existing IRA or simply treat the account as your own IRA.
If you’re a spousal beneficiary and you choose to treat the IRA as your own, you may reap personal finance benefits. That’s because you could get additional time to allow the funds to grow if your RMD schedule is later than your late spouse’s was, i.e., if you’re younger. And spousal inheritors who choose to roll over the funds into their own IRA accounts can continue to contribute to the retirement account as usual.
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In most cases, those who inherit a non-spousal IRA have the options of following the 10-year rule or taking a lump-sum distribution. But you have additional options if you’re a spousal beneficiary or an eligible designated beneficiary.
Additionally, the original benefactor’s year of death plays an important role, as many of these rules and options differ based on whether the original account holder died in 2019 or earlier, or after that year.
The distribution rules also consider whether the original account holder died before or after their required beginning date, which is to say, the date on which they would have been required to take their first RMD. If the original owner died in 2020 or later and they’d started RMDs, you’ll be required to take them each year, even if you’re following the 10-year rule.
The 10-year rule specifies that non-spouse beneficiaries must withdraw all of the funds from an inherited IRA by the end of the 10th year following the original owner’s death.
Even spousal beneficiaries whose benefactors died in 2020 or later may have to follow the 10-year rule if they keep the IRA as an inherited account. However, as stated above, they also have the option to treat the IRA as their own or to roll over the money into their own IRA.
In some instances, both spousal and non-spousal beneficiaries can take required minimum distributions based on their own life expectancies rather than the original account-holder’s. These RMDs are calculated using the normal RMD rules using life expectancy tables the IRS does update regularly. Annual RMDs are required starting in the year the account-holder turns age 72 (or 73 for those whose 72nd birthday falls after Dec. 31, 2022).
Finally, the inherited IRA rules allow beneficiaries to simply withdraw all the IRA assets as a single lump-sum distribution. But be aware that doing so may land you in a higher tax bracket if the funds are coming from a traditional IRA account, since withdrawals are taxed as regular income.
If you’ve inherited a Roth IRA, keep in mind that the Roth five-year rule still applies in order to withdraw funds tax-free.
Although it feels like a windfall, inheriting an IRA can also have income tax consequences—particularly if you withdraw the funds as a lump sum.
While inherited Roth IRAs may potentially be tax-free, traditional IRAs are only tax-deferred. You’ll still owe income taxes when you take IRA distributions. Traditional IRA distributions are treated as regular taxable income, so the addition of these funds to your annual income could push you into a higher income tax bracket.
One piece of good news? The regular withdrawal rules that state an IRA account-holder must reach age 59½ before taking distributions don’t apply to inherited IRAs. That means you don’t have to worry about the 10% early withdrawal penalty that would apply if the account were your own — unless you’re a spousal beneficiary who decided to roll over the funds into your own IRA account or treat it as your own.
While the inherited IRA account rules are confusing, a qualified financial advisor or tax advisor can make figuring it out easier, from opening your new account to getting set up to take your first IRA distributions. As a decedent, chances are you have plenty else on your mind aside from personal finance and estate planning matters, which is exactly why Capitalize is here to help. We work hard to make the 401(k) rollover process easy, no matter your circumstances. We’ll help you avoid unwanted tax-time surprises and make the most of your money—no matter where (or who) it came from.
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