By Donna Fuscaldo of Kiplinger’s Personal Finance
If you inherit an Individual Retirement Account (IRA), its windfall can be costly if you’re not careful. This is because there are rules regarding inherited IRAs to ensure that the money in the account is ultimately taxed and the IRS paid. Violating any of them can create an expensive tax event. Plus, you could be hit with fees and penalties.
Ed Slott & Co., an IRA distribution company in New York; Ed Slott, president of the company, said: “I’ve worked with parents and grandparents who don’t talk about inheritance with their kids. The kids get blown away, but don’t realize it’s taxable.”
What is an inherited IRA?
An inherited IRA, sometimes called a beneficiary IRA, is created when the IRA passes to a spouse, family member, or loved one when the account owner dies. Anyone can bequeath an IRA, but there are different rules depending on the beneficiary.
Assets in the original IRA must be transferred to the inherited IRA in the beneficiary’s name. No additional contributions can be made to an inherited IRA, but the funds remain tax deferred. If you are a non-spouse beneficiary, you must liquidate the entire account by the 10th anniversary of the account owner’s death. That’s where it gets tricky and potentially expensive, given that the distribution is treated as regular income.
“Children and grandchildren other than the spouse must empty the account at the end of the 10th year after death,” Slott says. “That’s a big tax hit in year 10” if you do nothing.
Inherited IRA Rules
IRA accounts inherited by a non-spouse after December 31, 2019 are subject to the 10-year rule thanks to the All Communities setting in the 2019 Retirement Enhancements (Secure) Act. There are some exemptions. The old rules apply if the beneficiary was within 10 years of the deceased, disabled or chronically ill, or a minor child of the deceased. You can withdraw money as much as you want. If the deceased had already begun making a Required Minimum Distribution (RMD) to kick in at age 73, the new IRA beneficiary must continue to do so for 10 years. The drawdown will be recalculated based on your life expectancy.
Although you can leave your IRA to anyone, the tax rules favor spouses. “Spouses have the most flexibility when inheriting assets,” says Sham Ganglani, retirement sales leader at Fidelity Investments. “They are the only ones who can treat the money as their own.”
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If you received an IRA from your deceased spouse, you have several options.
take over account
Become an IRA account owner via a spousal transfer. The money can be accessed immediately, but profits are taxed until age 59 1/2. Accounts must also meet the 5-year holding period rule. Its rules require you to own your account for five years before withdrawing. RMDs are based on the deceased account owner’s age, not their age, so they can be spread out over more years if you are younger. This helps lower your potential tax hit.
Open an inherited IRA
You can roll your assets into an inherited IRA. RMDs are required based on your life expectancy and the account must be emptied by the 10th year. Withdrawals are not subject to the 10% early withdrawal penalty as long as the 5-year rule is met. This may be beneficial for spouses under 59 1/2 who need access to money.
pause
As long as you’ve owned your inherited IRA for five years, you can take a lump sum distribution. The money is treated as regular income, but if you are under age 59 1/2, it is not subject to the 10% early withdrawal penalty. Cashing out can push you into a higher tax bracket. This means more income tax is paid.
Rules for non-spouses inheriting an IRA
For non-spouse beneficiaries who do not meet the exemption, the rules are less flexible and options are limited to:
Open an inherited IRA
RMDs are based on your life expectancy and the 10-year rule applies. The 10% early withdrawal penalty will not occur. Assets continue to grow tax deferred.
cash out
Paying taxes on lump sum distributions is not subject to the 10% early withdrawal penalty if you hold the account for 5 years. This strategy can push you into a higher tax bracket.
conclusion
When it comes to handling inherited IRA requirements, financial advisors say spreading out withdrawals over several years is the best way to lower the tax impact. The beauty of an inherited IRA is that you can withdraw it within an additional year if you need it without facing penalties. “Try not to pick the amount of the lump,” says Ganglani. “That’s a tax consideration that a lot of people don’t think about.”
Once you have an inherited IRA, don’t let loyalty prevent you from changing your holdings in the account. They may have worked for your benefactor, but they may not be the best investment for your goals. “If the investments you inherited don’t meet your risk and goals for saving and growing your wealth, don’t be afraid to reallocate them,” says Ganglani. “Don’t think this is your dad’s IRA.”
©2025 The Kiplinger Washington Editors, Inc. Distributed by Tribune Content Agency, LLC.
The views and opinions expressed are those of the author. They are for general information purposes only and should not be interpreted or construed as a recommendation or solicitation. Epoch Times does not provide investment, tax, legal, financial planning, estate planning, or other personal financial advice. Epoch Times is not responsible for the accuracy or timeliness of the information provided.
