Inheriting an IRA: What You Need to Know
Settling an estate is no easy task. Receiving bequests from someone after their death can bring up many feelings, including confusion about your best next steps. If you are a beneficiary of a loved one’s estate, you may wonder how to handle the assets you’ve received.
Receiving a lump sum is relatively simple to navigate, but inheriting an individual retirement account can come with complexities regarding taxes and distributions. To avoid costly mistakes, educate yourself on this kind of inheritance before receiving the account.
What Is an Inherited IRA?
An inherited IRA, also called a beneficiary IRA, is an account that’s operated by the beneficiary after inheriting a retirement plan from someone else. Inherited IRAs are just one part of a decedent’s potential estate plan. Beneficiaries can inherit both traditional and Roth IRAs, and both follow the tax treatment of the original account.
An inherited IRA differs from a retirement account opened in your own name in several important ways. You do not have to wait until your own retirement to collect funds from an inherited IRA, but you may be required to take required minimum annual distribution payments (RMDs). In many cases, you will need to withdraw all funds within a specific amount of time after the original account owner’s death. Inherited IRAs have different rules depending upon the type of beneficiary.
Who Can Inherit an IRA?
The Setting Every Community Up for Retirement Enhancement (SECURE) Act was enacted in 2019 and updated in 2022. This legislation was designed to help Americans save for retirement and improve their financial security in their retirement years. One part of the SECURE Act designated three types of beneficiaries for retirement accounts.
Eligible Designated Beneficiaries
Eligible designated beneficiaries (EDBs) are eligible for more withdrawal and transfer options related to an inherited IRA. EDBs include:
- The IRA owner’s surviving spouse
- The IRA owner’s child (under age 21)
- A designated disabled or chronically ill individual
- A designated individual (must be 10 or less years younger than the IRA owner)
Surviving spouses have more options than any other type of IRA beneficiary. They can transfer some or all of the funds into their own IRA and treat it as their own, which means they can continue to make contributions if they choose. They can take a lump sum distribution without incurring an early withdrawal penalty. They can transfer the assets into an inherited IRA and distribute within 10 years of decedent’s death (“the 10-year rule”) or through required mandatory distribution based on remaining life expectancy of decedent or spouse without incurring 10% early withdrawal penalties. If the decedent’s IRA was already in the RMD stage, the surviving spouse would be required to continue taking annual RMD based on their life expectancy.
Non-spousal EDBs cannot move funds into their existing IRAs, but they can transfer the assets into an inherited IRA and choose how to distribute the funds. They can opt for a single lump sum payment, withdraw distributions over the course of their lifetime (following required minimum distribution limits, based on the remaining life expectancy of the decedent or their own), or follow the 10-year rule, which requires that they withdraw the full amount in the original IRA account by the end of the tenth year after the account owner’s death.
Designated Beneficiaries
Designated beneficiaries include children of the deceased who are not minors and named non-spousal beneficiaries who are more than 10 years younger than the deceased. Designated beneficiaries are still permitted to receive an inherited IRA, but they must follow the 10-year rule outlined above.
Non-Individual Beneficiaries
Non-individual beneficiaries are typically estates, trusts, or charities, as opposed to named individuals. This group of beneficiaries has fewer options. If the IRA account owner had already started taking RMDs, the RMD distributions would continue to the non-individual beneficiary based on the remaining life expectancy of the original account owner. If RMDs had not started then the “5-year rule” applies. The 5-year rule requires all assets to be distributed by the end of the fifth year after the original IRA owner’s death.
What Can I Do With an Inherited IRA?
Although most types of beneficiaries cannot contribute additional funds to an inherited IRA, they do have choices when it comes to distributing existing funds. Each of these choices has tax implications, so you should consider all options and potentially discuss with a tax professional before making a decision.
1. Take a single lump-sum distribution.
All types of beneficiaries can take advantage of this option. However, individuals and entities alike must be aware of the tax consequences that could come with a single lump sum payment. If the original account is a traditional IRA, beneficiaries must pay taxes on withdrawals. Depending on the funds in the IRA and your current income, accepting all assets at once could push you into a higher tax bracket. This option also removes the possibility of future tax-deferred growth.
2. Transfer assets into a new inherited IRA.
Opening an inherited IRA in your own name allows you to follow a distribution schedule instead of facing potential tax consequences from a lump sum. There are two ways to distribute your inherited assets:
- Follow the 10-year rule, which means emptying the account by the end of the tenth year after the original owner’s death. For example, if the original IRA owner passed away in March of 2025, the account must be liquidated by December 31, 2035.
- Opt to take required minimum distributions (RMDs) based on your life expectancy.
If you’re unsure which options are available to you or can’t decide which one is best for your financial situation, talk to your financial advisor or retirement professional about tax planning and other potential advantages or disadvantages.
3. Transfer the funds into your own IRA.
As a reminder, this option provides the most flexibility — but it’s only available for surviving spouses. Consult your retirement advisor to determine how this transfer can impact your retirement calculations.
4. Pass on receiving the inherited IRA.
In some cases, individuals choose not to accept the inherited IRA at all. This may be a good option if you want to avoid receiving funds that will push you into a higher tax bracket or if another family member’s needs would benefit from the account more than yours. This option can come with its own complexities, so talk to a financial professional before choosing not to inherit.
Creating a Plan for Inherited Assets
Inheriting an IRA can be complex. To make the most of this benefit from a loved one, sit down with a financial advisor you trust. They can help you assess your options and tax consequences while addressing your financial needs in the years ahead.
At Marietta Wealth, we understand that every inheritance situation is unique. Our team of advisors is dedicated to creating a sound plan for each individual’s financial situation, needs, and goals. We build trust through personal relationships, so we’d love to get to know you. If you’re navigating an inherited IRA or other bequests from a loved one who has passed away, we are here to support your peace of mind as you make these important decisions.
Begin your journey to peace of mind with Marietta Wealth today.
Marietta Wealth is a registered investment adviser. Registration of an investment adviser does not imply any level of skill or training. For additional information about Marietta Wealth’s financial planning and advisory services, please see the Marietta Wealth Disclosure Brochure or ADV Part 2A for full details, which is available upon request or by visiting our website.
This article is not intended to be used, and should not be used, as the sole basis for legal advice. The reader should seek and rely upon the guidance and advice of legal counsel before making decisions regarding any estate planning tools or documents.