Can I inherit an IRA?
Published on August 22, 2024
by Grace Lorraine Angeles
Grace Lorraine, an IRS Enrolled Agent and CPA with 13 years of expat tax experience, specializes in US tax preparation, tax planning, and tax advice for US citizens and Green Card holders living and working abroad.
Table of Contents
Yes, you can inherit an IRA.
When the original owner of an IRA (Individual Retirement Account) passes away, the account can be transferred to a beneficiary, who then becomes the owner of what is called an Inherited IRA.
Who can inherit an IRA?
Several types of beneficiaries can inherit an IRA.
However, the distribution rules vary depending on the type of beneficiary:
Types of Beneficiaries
- Spouses:
- Spouses have the most flexibility. They can treat the inherited IRA as their own, roll it over into their IRA, or remain as the beneficiary.
- Distribution Rules: If they treat it as their own, they follow the same rules as their IRA. If they remain as a beneficiary, they must take Required Minimum Distributions (RMDs) based on their life expectancy.
- Non-Spouses:
- Non-spouses cannot treat the inherited IRA as their own. They must take distributions according to specific rules.
- Distribution Rules: Most non-spouse beneficiaries must withdraw all funds within ten years of the original owner’s death, known as the 10-year rule. Exceptions apply to eligible designated beneficiaries (EDBs) who can stretch distributions over their life expectancy.
- Trusts:
- A trust can be named as a beneficiary, which can help control how the assets are distributed.
- Distribution Rules: If certain requirements are met, the trust can take distributions over the life expectancy of the oldest trust beneficiary.
- Estates:
- An estate can be named as a beneficiary if no individual or trust is designated.
- Distribution Rules: Typically, the estate must withdraw all funds according to the 5-year rule if the owner died before starting RMDs or over the owner’s remaining life expectancy if they had begun RMDs.
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What are the distribution rules for spousal beneficiaries?
Spouses who inherit an IRA have several options for how they can handle the account:
- Treat as Their Own IRA: The spouse can treat the inherited IRA as their own. This means they can contribute to the IRA and take distributions as if they were the original owner.
- Roll Over to Another IRA: The spouse can roll over the inherited IRA into their own existing IRA.
- Remain as a Beneficiary: The spouse can choose to remain as the beneficiary of the inherited IRA.
However, a few of these options must follow Required Minimum Distributions (RMDs).
Required Minimum Distributions (RMDs) are minimum amounts that IRA and retirement plan account owners generally must withdraw annually starting with the year they reach 72 (73 if you reach 72 after Dec. 31, 2022).
Required Minimum Distributions (RMDs) for Spousal Beneficiaries
- Treat as Own IRA: If the spouse treats the IRA as their own, RMDs are based on their age and the same rules that apply to any IRA owner.
- Remain as Beneficiary: If the spouse remains a beneficiary, RMDs must begin by December 31 of the year after the original owner’s death if the owner was already taking RMDs. If the original owner had not started RMDs, the spouse can delay distributions until the year the original owner would have turned 72.
How different is an IRA from a 529 Plan?
An IRA is a savings account designed specifically for retirement.
It allows individuals to save money for their retirement years with tax benefits, depending on the type of IRA (Traditional or Roth).
The primary goal of an IRA is to provide financial security during retirement.
On the other hand, a 529 Plan is a savings plan designed to help families save for future education costs, such as college tuition and other qualified education expenses.
The main purpose of a 529 Plan is to cover educational costs with tax-advantaged growth—meaning the earnings on these contributions are also tax-free, as long as the withdrawals are used for qualified education expenses.
What are the distribution rules for non-spousal beneficiaries?
Most non-spousal beneficiaries must withdraw all funds from the inherited IRA within 10 years of the original owner’s death. There are no annual RMDs required, but the entire balance must be distributed by the end of the 10th year.
However, there are exceptions to the 10-year rule (Eligible Designated Beneficiaries).
- Minor children of the original owner (until they reach the age of majority)
- Disabled individuals
- Chronically ill individuals
- Individuals not more than 10 years younger than the original owner
Additionally, there’s the Life Expectancy Option—EDBs can take distributions over their life expectancy, potentially stretching the IRA over a longer period.
Required Minimum Distributions (RMDs) for Non-Spousal Beneficiaries
- Under the 10-Year Rule: There are no annual RMDs, but the entire IRA balance must be distributed within 10 years.
- For EDBs Using Life Expectancy: RMDs are based on the beneficiary’s life expectancy, which can allow for smaller distributions spread over a longer period.
What happens if the IRA owner died before January 1, 2020?
If the IRA owner died before January 1, 2020, the distribution rules are different due to the SECURE Act, which took effect on that date.
Why is January 1, 2020, special?
The SECURE Act (Setting Every Community Up for Retirement Enhancement Act) came into effect on January 1, 2020. This law significantly changed retirement account rules, especially for inherited IRAs.
What is the SECURE Act?
This legislation introduced several changes to enhance retirement security by making it easier for Americans to save for retirement and access their savings, such as:
- Eliminating the Stretch IRA: Previously, beneficiaries could “stretch” distributions over their lifetime, minimizing the tax impact. This was particularly beneficial for younger beneficiaries.
- Introducing the 10-Year Rule: The SECURE Act requires most non-spouse beneficiaries to withdraw all funds from an inherited IRA within 10 years of the original owner’s death.
- Raising the RMD Age: The age at which individuals must start taking Required Minimum Distributions (RMDs) was raised from 70½ to 72. This allows retirement accounts to grow tax-deferred for an additional 1½ years.
- Penalty-Free Withdrawals for Birth or Adoption: The Act allows for penalty-free withdrawals of up to US$5,000 from retirement accounts for expenses related to the birth or adoption of a child.
- Expanded Access to Annuities: The Act encourages the inclusion of annuities in retirement plans, providing more options for retirees to receive a steady income stream.
- Part-Time Workers: The SECURE Act makes it easier for part-time workers to participate in 401(k) plans. Employees who work at least 500 hours per year for three consecutive years are now eligible to participate.
- Repealing the Age Limit for IRA Contributions: Previously, individuals over 70½ could not make contributions to a traditional IRA. The SECURE Act repeals this age limit, allowing contributions as long as the individual has earned income.
To summarize, before January 1, 2020, beneficiaries could use the stretch IRA rules to take distributions over their life expectancy.
However, after January 1, 2020, most non-spouse beneficiaries must withdraw all funds within 10 years. Exceptions are made for eligible designated beneficiaries (EDBs), such as minor children, disabled individuals, chronically ill individuals, and those not more than 10 years younger than the original owner, who can still use the stretch IRA rules.
What are the tax implications of inherited IRA distributions?
Inherited IRA distributions are generally taxed as ordinary income.
When you take a distribution from an inherited IRA, the amount you withdraw is added to your taxable income for that year. This means it is taxed at your current income tax rate.
Can a beneficiary refuse an inherited IRA?
Yes, a beneficiary can refuse an inherited IRA. This process is known as disclaiming the IRA.
What if there are multiple beneficiaries?
When there are multiple beneficiaries, each beneficiary can choose their own distribution method. The IRA can be split into separate accounts for each beneficiary, allowing individual control over their inherited portion.
Separate Accounts
If the IRA is divided into separate accounts by December 31 of the year following the original owner’s death, each beneficiary can take distributions based on their own life expectancy or under the 10-year rule.
Combined Accounts
If the IRA is not split, the distribution rules are based on the oldest beneficiary’s life expectancy or the 10-year rule.
What happens if the beneficiary is a minor?
When a minor inherits an IRA, special rules apply to ensure the funds are managed appropriately until the minor reaches the age of majority.
- Required Minimum Distributions (RMDs): Minor beneficiaries are considered eligible designated beneficiaries (EDBs) and can take RMDs based on their life expectancy until they reach the age of majority.
- 10-Year Rule: Once the minor reaches the age of majority (typically 18 or 21, depending on state law), the 10-year rule applies, requiring the entire balance to be withdrawn within 10 years.
Can an inherited IRA be converted to a Roth IRA?
It depends. An inherited IRA cannot be converted to a Roth IRA by a non-spouse beneficiary.
However, a spousal beneficiary can roll the inherited IRA into their own IRA, which can then be converted to a Roth IRA if desired.
Are there penalties for early withdrawals from an inherited IRA?
No, there are no early withdrawal penalties for taking distributions from an inherited IRA, regardless of the beneficiary’s age.
This rule applies because inherited IRAs have different distribution requirements compared to traditional IRAs.
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