Inherited IRA Rules: Key Considerations for Beneficiaries
Oct 17, 2024
Key Takeaways:
- An inherited IRA is a retirement account passed on to a beneficiary after the original owner’s death.
- New rules introduced in 2024 have changed the timing for required minimum distributions (RMDs).
- How you handle an inherited IRA depends on factors like your relationship to the original owner and whether the account is a traditional or Roth IRA.
Every year, millions of people inherit assets from loved ones—ranging from real estate to investment accounts and individual retirement accounts (IRAs). If you’ve recently inherited an IRA, it’s important to understand the rules that govern these accounts to avoid penalties or unexpected taxes.
Recent IRS guidance has added new complexities. In 2022, changes to RMD requirements created confusion for beneficiaries, particularly those inheriting IRAs from individuals who passed away after 2019. In 2024, the IRS finalized rules, adding clarity on when beneficiaries must begin distributions—but these changes come with some nuances. Below, we break down what inherited IRAs are, how they work, and the factors that will shape your options.
What Is an Inherited IRA?
An inherited IRA, also known as a beneficiary IRA, is an account opened by someone who receives a retirement account following the original owner’s death. Unlike a standard IRA, beneficiaries cannot make new contributions to an inherited IRA, though the funds in the account can continue to grow with tax benefits.
What you can and must do with the inherited IRA will depend on several factors—such as whether the original owner passed away before or after 2020, whether the beneficiary is a spouse or non-spouse, and whether the IRA is traditional or Roth.
How Traditional and Roth IRAs Work
A traditional IRA allows the original owner to make tax-deductible contributions, with the funds growing tax-deferred. Distributions from a traditional IRA are taxed as income when taken.
In contrast, Roth IRAs are funded with after-tax dollars, and qualified withdrawals are generally tax-free. During the original owner’s lifetime, Roth IRAs do not have required minimum distributions (RMDs), offering additional flexibility.
Key Factors That Influence Inherited IRA Rules
When the Original Owner Passed Away
The rules for non-spouse beneficiaries changed with the 2019 SECURE Act. Before 2020, non-spouse beneficiaries could stretch distributions over their lifetime. Now, if the IRA owner passed away in 2020 or later, most non-spouse beneficiaries must fully distribute the account within 10 years of the original owner’s death.
Spousal vs. Non-Spouse Beneficiaries
Spouses have more flexibility than other beneficiaries. If you inherit an IRA from a spouse, you can:
- Roll the funds into your own IRA, treating it as if it were your own account.
- Open an inherited IRA and take distributions based on the original owner’s age and the RMD rules.
- Take a lump-sum distribution of the account balance.
However, RMD rules still apply, and failure to meet these requirements could trigger a 25% penalty on the amount not withdrawn.
Required Beginning Date (RBD) and RMDs
The RBD refers to the deadline for starting required minimum distributions from retirement accounts. Recent changes under the SECURE 2.0 Act shifted the RBD to age 72 or 73, depending on the birth year of the original owner, with plans to increase the RBD to 75 in the future.
If the IRA owner passed away before their RBD, non-spouse beneficiaries don’t need to take annual RMDs but must distribute the entire account by year 10.
If the owner died after their RBD, new rules will require annual distributions starting in 2025, with the account fully distributed by the end of the tenth year.
Traditional vs. Roth IRA Differences
Roth IRAs do not have RMDs during the owner’s lifetime, which means there is no RBD for Roth accounts. While beneficiaries are not required to take annual distributions from an inherited Roth IRA, the account must be emptied by the end of year 10. Since Roth distributions are typically tax-free, many beneficiaries leave the funds untouched for as long as possible to maximize tax-free growth.
How to Approach Inherited IRA Decisions
Managing an inherited IRA can feel overwhelming, especially with changing rules. Deciding how and when to take distributions is critical—not just to avoid penalties but also to manage taxes effectively. For instance, while lump-sum distributions may be convenient, they could push you into a higher tax bracket for the year.
If you’ve inherited a Roth IRA, it may make sense to leave the funds in the account for as long as possible to take advantage of tax-free growth. On the other hand, traditional IRA beneficiaries will need to plan carefully to meet RMD requirements without incurring unnecessary taxes.
The Value of Professional Guidance
When it comes to inherited IRAs, the rules can be complex, and every situation is unique. Consulting with a financial advisor and a tax professional can help ensure you make the best decisions for your financial future. Your advisor can help you align the inheritance with your broader financial goals, while a tax expert can ensure compliance with IRS regulations and minimize tax liability.
The Bottom Line: Plan Carefully to Maximize Your Inheritance
Receiving an inherited IRA is an opportunity to secure long-term financial benefits, but careful planning is essential. The new rules may require adjustments to how you handle distributions, and working with professionals can provide peace of mind as you navigate these decisions.
Whether you're a spouse rolling the IRA into your own account or a non-spouse beneficiary managing distributions over time, the key is to understand your options and choose a strategy that fits your financial needs and goals. Taking the time to plan today can help you avoid costly mistakes down the road—and make the most of what your loved one left behind.
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