What Is the Best Thing to Do with an Inherited IRA?
Inheriting an IRA from a parent involves specific rules that beneficiaries must follow to maximize the inheritance and avoid tax penalties.
Common Mistake to Avoid
Many heirs mistakenly transfer an inherited IRA into their own account. This approach violates IRS requirements and can trigger unintended consequences. Instead, assets must be transferred to a properly titled account designated as an “Inherited IRA.”
Proper Account Setup
The inherited account must be titled to reflect the deceased owner’s name along with the phrase “For the benefit of…” followed by the beneficiary’s name. Financial institutions may have slight variations in titling conventions, but this detail is critical for compliance.
When multiple beneficiaries exist, the IRA must be divided into separate accounts for each heir. Each beneficiary then manages their portion according to the same rules as a sole beneficiary would.
Beneficiaries can establish the inherited account with their chosen financial institution or use the previous account holder’s firm, whichever is more convenient.
The 10-Year Withdrawal Rule
The SECURE Act, enacted in December 2019, changed inherited IRA distribution requirements significantly. Most beneficiaries must now deplete inherited IRAs within ten years of the original owner’s death (for accounts where the owner passed after December 31, 2019).
Previously, “Stretch IRAs” allowed beneficiaries to withdraw funds over their lifetime, permitting tax-deferred growth and often enabling transfers to subsequent generations. This option no longer exists.
While withdrawal frequency and amounts are unrestricted, all funds must be distributed within the decade. Withdrawals are taxable as ordinary income, so delaying until the final year triggers a substantial tax bill.
Notable Exceptions
Certain beneficiaries receive extended timelines:
- Surviving spouses
- Minor children
- Disabled or chronically ill beneficiaries
- Beneficiaries within ten years of the original owner’s age
Spouse Beneficiaries
Spouses enjoy unique advantages. They can transfer the IRA into their own account and postpone distributions until age 72.
Estate Planning Considerations
When developing an estate plan, individuals should consider whether heirs can afford taxes on inherited IRAs. Converting accounts to Roth IRAs during the planning phase can eliminate future tax burdens for beneficiaries. These matters warrant consultation with an estate planning attorney.
If you have questions about inherited IRAs and how they fit into your estate plan, contact our office to schedule a consultation.
