Beneficiaries who inherit an IRA should seek advice from a fiduciary financial professional before trying to manage it themselves, since the process can be complex.
Example: the marital status and medical needs of the deceased IRA owner will have an impact on what can be done with their funds, as will the type of account in which it resides.
Taxes
When inheriting an IRA, it’s crucial that you understand its tax implications. To get a start on this research process, visit the IRS website which has detailed rules about IRA distributions; should additional details be needed, speak with your IRA custodian or seek professional advice for guidance specific to your case from financial professionals or tax attorneys.
Beneficiaries of an inherited Roth IRA have until December 31 of the 10th year after its original owner has passed away to empty it. They can take withdrawals according to life expectancy or make equal amounts withdrawals each year; choosing this latter method allows for spreading withdrawals across several years if their income drops significantly in any one year and thus potentially lowering taxes overall. A 2019 law changed this rule; now all non-spouse beneficiaries must empty their accounts within 10 years or face penalties.
Required minimum distributions
If your loved one entrusted their IRA assets to you, it’s your responsibility to take required minimum distributions from their account within 10 years of his or her death and calculate an RMD amount based on his or her life expectancy.
Non-spouse beneficiaries follow similar RMD rules as those for traditional IRAs in regard to Roth IRAs: starting withdrawals by Dec 31 of the year following an account owner’s death and emptying it within 10 years (exceptions apply if disabled, chronically ill or underage beneficiaries exist).
Beneficiaries can get around this rule by rolling their inherited assets into individual retirement accounts (IRAs). This strategy works best if the beneficiary is over age 59 1/2 as this allows them to avoid a 10% early withdrawal penalty; however, mixing up non-inherited and inherited assets could create tax complications, according to Gagnon.
Withdrawals
Before the SECURE Act was signed into law in 2019, tax rules allowed beneficiaries of traditional IRAs to extend withdrawals across their lifetimes, but now, unless you belong to one of a special group of beneficiaries, all funds must be exhausted within 10 years.
There are still ways around the 10-year rule and enjoy tax-deferred growth on an inherited Roth IRA, depending on your relationship to the deceased and when they died.
If you are married to the account owner or are eligible designated beneficiary, taking over their IRA (also known as a “spousal transfer or rollover”) allows for taking Required Minimum Distributions over your own life expectancy instead of the deceased spouse and eliminates the 10% early withdrawal penalty. Withdrawals will still incur ordinary income taxes however; as with other investments you could use this cash as you see fit – or withdraw it as one lump sum payment in future years.
Rolling the account into your own IRA
As Inherited Roth IRAs can have complex rules, you should always consult with a tax adviser prior to making major decisions regarding them. You may find help at the IRS website which offers comprehensive rules regarding distributions from IRAs.
IRAs offer many unique benefits: earnings and interest accrue tax-free while withdrawals may be subject to ordinary income tax unless coming from an inherited Roth account. There may be instances in which rolling over assets into an IRA may make sense.
Assuming ownership of your deceased partner’s IRA can allow you to reset its required minimum distribution schedule based on your life expectancy, avoiding penalties for withdrawals made before age 59 1/2. Or you could roll it over into an existing IRA in your name and continue contributing – an option which might be advantageous if younger than the original owner or chronically ill or disabled individuals wish to make withdrawals before age 59 1/2.
