What do I do with an inherited IRA?
If you inherited an IRA, you must decide what to do with the inherited assets. If you are a spouse or a non-spouse beneficiary, find out the options you have.
If you recently inherited an IRA, you should decide what to do with the money to avoid a tax-time surprise. What you can do with the money depends on your relationship with the original account owner. If you don’t make an informed decision on the inherited assets, you could lose a portion of the money to taxes and penalties.
If you are the spousal beneficiary, you can take over the IRA as your own and continue taking distributions if your spouse was above 72. You can also transfer the assets to an inherited IRA, and spread distributions over your lifetime. However, if you are a child, grandchild, or other non-spousal beneficiary, you can take a lump-sum distribution, or transfer the assets to an inherited IRA. You must take a full payout of the inherited assets by the 10th year of the account owner’s death.
What is an inherited IRA?
When you inherit retirement assets from a deceased person, you can transfer these assets to an account known as an inherited IRA. Any person or estate who is among the listed beneficiaries can inherit the IRA, but there are different rules on how the inherited IRA is treated depending on whether you are the spouse or a non-spousal beneficiary.
Generally, any type of IRA inherited from the original account owner may be turned into an inherited IRA. Whether the deceased person has a SEP IRA, Traditional IRA, or Roth IRA, these retirement plans are transferred into an inherited IRA when the original account owner dies. The tax treatment of the original IRA remains the same in the inherited IRA. For example, if you inherited a Roth IRA from the original account owner, you will be able to take tax-free distribution if you meet the Roth withdrawal rules.
What happens when you inherit an IRA as a spouse?
If you are the spouse of the deceased person, you may have several options with the money. Here are your options with the inherited IRA:
You can take ownership of the inherited IRA, and even roll it into your traditional IRA. You will name yourself the owner, and the account will have the same rules as the original account. The inherited retirement savings will continue growing tax-deferred, and you can take penalty-free distributions once you are 59 ½.
Take Lifetime Distributions
When you transfer the inherited assets into an inherited IRA, you can stretch distributions over your lifetime. You must take mandatory distributions when the original account owner would have turned 72, or on December 31 of the following year after the account owner's death, whichever is greater. If the account owner had already reached age 72, you must start taking distributions by December 31 of the following year after the account owner's death.
The Five-Year Rule
If you inherit an IRA and the original account owner had not turned 72, you can postpone taking any distributions as long as you take the full payout by the end of the fifth year after the account owner’s death. You will pay taxes on the distributions, but you will be exempted from the 10% early distribution penalty, even if you are below age 59 ½.
What happens when you inherit an IRA as a Non-Spouse Beneficiary?
If you are a son, daughter, or grandchild of a deceased person, you will receive inherited assets if you are a named beneficiary. The SECURE Act introduced the 10-year rule for distributions, and it requires non-spousal beneficiaries to empty the inherited IRA by the 10th year after the account owner’s death.
Here are your options with the inherited IRA:
If you inherited IRA from a parent, you can move the inherited assets into an inherited IRA, also known as a beneficiary distribution account. The account remains in the original account owner’s name. You can then start taking distributions from the inherited IRA.
As a non-spouse beneficiary, you can transfer the inherited assets into an inherited IRA. If the account owner died after December 31, 2019, you must empty the account within 10 years after the account owner's death. Exceptions to the 10-year rule include a child who is a minor, a chronically ill beneficiary, a disabled beneficiary, and a surviving spouse (s).
After inheriting the retirement assets, you can opt to take a lump-sum distribution. If you inherited a traditional IRA, you will owe income taxes on the distribution. However, you will be exempted from the 10% early distribution penalty. For Roth IRA, you will take tax and penalty-free distributions as long as the account is five years old.