Inheriting an individual retirement account can be a bittersweet experience. Although it’s a loving gesture from the deceased to help fortify your retirement, the machinations of an inherited IRA tend to be more complicated than the average recipient may realize. Once you’re able, sit down with a trusted financial advisor who understands the rights and obligations that come with your new IRA.
It’s critical to thoroughly vet Internal Revenue Service rules on inherited IRAs, especially tax triggers and penalties. As you navigate the obligations of an inherited IRA, consider the following:
— What is an inherited IRA?
— Remember the first required minimum distribution.
— Be mindful of the 10-year rule.
— Take action to minimize taxes.
— Label the account correctly.·
— Consider separating accounts.
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What Is an Inherited IRA?
An inherited IRA is an individual retirement account passed down to a beneficiary after the original owner’s death.
“Retirement savers should know about inherited IRAs because they have different rules and tax implications compared to regular IRAs,” said James Carlson, a financial planner at Carlson Planning Company in Mansfield, Massachusetts, in an email. “Beneficiaries of inherited IRAs must understand their options for withdrawing funds and the potential tax consequences to make informed decisions.”
The first step when inheriting an IRA is to inform the financial institution that manages the account of the original owner’s passing.
“This will trigger a transfer of ownership from the deceased individual to the beneficiary,” Carlson noted. “It’s important for beneficiaries to gather all necessary information, such as account statements and beneficiary designations, to properly manage the inherited IRA.”
Remember the First Required Minimum Distribution
How distributions from your IRA are taxed depends on whether it’s a pretax traditional account or a post-tax Roth account. “If you inherit a pretax IRA, every distribution will be fully taxable as ordinary income,” said Katherine Fox, certified financial planner and founder of Sunnybranch Wealth in Portland, Oregon, in an email. “If you inherit a post-tax Roth IRA, you won’t be taxed on distributions taken from the account.”
The responsibility for taking required minimum distributions from an inherited IRA depends on the age of the decedent. “If the person was already required to be taking their RMDs, you will also be responsible for taking annual distributions from the account,” Fox said. “If you don’t, you could be subject to a hefty penalty from the IRS.”
The calculation for your RMD from an inherited IRA is based on your life expectancy or the decedent’s, whichever is greater. “This means that each year, a certain percentage of the account balance must be withdrawn and subject to income taxes,” Carlson said.
[Read: What the Rothification of Retirement Accounts Means for You]
Be Mindful of the 10-Year Rule
Inherited IRA owners should also get a grip on the 10-year rule for inherited IRA distributions, which states that most beneficiaries must withdraw all funds from an inherited IRA within 10 years of the original owner’s death. “This rule was established by the Setting Every Community Up for Retirement Enhancement Act (or SECURE Act) in 2019 and replaced previous rules which allowed beneficiaries to take RMDs over their own life expectancy,” Carlson added.
There are certain exceptions to the 10-year rule, such as if the beneficiary is a surviving spouse, a minor child, a disabled or chronically ill individual or someone who is not more than 10 years younger than the original owner. “These individuals may still be able to take RMDs over their life expectancy,” Carlson noted.
Take Action to Minimize Taxes
Inherited IRA recipients should aim for plan strategies that minimize taxes.
“If the assets received have come directly from your deceased spouse, you can liquidate the IRA over your lifetime, a tax-minimizing strategy called a ‘stretch IRA,'” said Vincent R. Birardi, senior financial planner at Halbert Hargrove, in Long Beach, California, in an email. “You’ll only be on the hook to take annual RMDs, which will be treated as taxable income for you.”
However, in most cases, if the assets were received from anyone else — for example, a deceased parent — then you can no longer do a stretch IRA. “Instead, you must liquidate the entire account within the next 10 years,” Birardi said.
Time-wise, inherited IRA recipients should start planning for their withdrawals as soon as possible after their loved one’s death.
“Every year, I recommend inheritors divide the account by the number of years left in their mandatory withdrawal period and withdraw at least that amount,” Fox said. “For instance, in year one, you would withdraw 10% of your IRA. In year two, you would withdraw 11%, in year three, take 12.5% and so on.”
IRA recipients should also know that associated withdrawal percentages may need to be adjusted depending on the rate of return you are earning on investments in your inherited IRA. Additionally, your financial health is a key consideration in how you approach inherited IRA taxes.
“If you think you’ll have a significant drop in income during the required 10-year withdrawal period, you may plan to take a larger distribution in that year, when your base level of taxable income will be lower,” Fox noted.
[Read: $1K Trump Accounts Are Coming: Experts Weigh In on Who Qualifies, Benefits and Drawbacks]
Label the Account Correctly
Inherited IRA recipients should verify that their IRA paperwork is correct and easily understood.
“Make sure the account is labeled as an inherited IRA with the deceased person’s name and your name as the beneficiary,” Carlson said. “This ensures that you follow the correct rules for distributions.”
It’s also a good idea to list all beneficiaries on the account, which ensures the account will avoid probate court if the owner passes away.
You can move the money from an inherited IRA to a new financial institution without incurring taxes or penalties. If you make a trustee-to-trustee transfer into another IRA setup, it must be maintained in the name of the deceased IRA owner to benefit the beneficiary. Distributions from the new IRA must adhere to the same beneficiary distribution rules as under the old IRA.
Consider Separating Accounts
If there are multiple beneficiaries, it’s often a good idea to split the inherited IRA into separate accounts. “This way, each beneficiary can manage their own distributions according to their financial needs and the required rules,” Carlson said.
Leveraging separate accounts also makes it easier for plan beneficiaries to take required minimum distributions without any delays. Separate accounts can also be especially beneficial if one or more beneficiaries qualify for an exception to the 10-year withdrawal rule.
As always, speak with a financial advisor who can walk you through the process of handling separate IRA accounts and inherited IRAs.
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How to Manage an Inherited IRA originally appeared on usnews.com
Update 08/20/25: This story was published at an earlier date and has been updated with new information.
