Inherited IRA: Definition and Tax Rules for Spouses and Non-Spouses

What Is an Inherited IRA?

An inherited IRA is an account that is opened when an individual inherits an IRA or employer-sponsored retirement plan after the original owner dies. The individual inheriting the Individual Retirement Account (IRA) (the beneficiary) may be anyone—a spouse, relative, unrelated party, or entity (e.g., estate or trust). Rules on how to handle an inherited IRA differ for spouses and non-spouses, however.

An inherited IRA is also known as a "beneficiary IRA." Many of the top brokers for IRAs provide support in resolving these matters related to the inheritance of IRA assets, taxation issues, and continuation of retirement account status. 

Tax laws surrounding inherited IRAs are quite complicated, and they became even more so with the Setting Every Community Up For Retirement Enhancement (SECURE) Act of 2019, which made some significant changes to the regulations—mainly for non-spousal heirs.

Key Takeaways

  • An inherited IRA, also known as a beneficiary IRA, is an account that is opened when an individual inherits an IRA or employer-sponsored retirement plan after the original owner dies.
  • Additional contributions may not be made to an inherited IRA.
  • Rules vary for spousal and non-spousal beneficiaries of inherited IRAs.
  • The SECURE Act mandated that non-spousal beneficiaries must empty inherited IRAs within a decade.
  • Traditional IRA owners must now take required minimum distributions starting at age 73, though withdrawal rules are different for Roth IRAs.

Understanding the Inherited IRA

A beneficiary may open an inherited IRA using the proceeds from any type of IRA, including traditional, Roth, rollover, SEP, and SIMPLE IRAs. Generally, assets held in the deceased individual’s IRA must be transferred into a new inherited IRA in the beneficiary’s name.

This transfer must be made even if a lump-sum distribution is planned. Additional contributions may not be made to an inherited IRA.

The Internal Revenue Service provides guidelines for inherited IRA beneficiaries. IRS forms 1099-R and 5498 are required for reporting inherited IRAs and their distributions for tax purposes.

Inherited IRAs are treated the same, whether they are traditional IRAs or Roth IRAs. The tax treatment of withdrawals does vary—consistent with the type of IRA (funded with pre-tax dollars, like the traditional type, or post-tax dollars, like the Roth).

Inherited IRAs: Rules for Spouses

Spouses have more flexibility in how to handle an inherited IRA. For one, they can roll over the IRA, or a part of the IRA, into their own existing individual retirement accounts; the big advantage of this is the ability to defer required minimum distributions (RMDs) of the funds until they reach the age of 73.

RMDs previously began at 70½, but the age was raised to 72 following the December 2019 passage of the Setting Every Community Up For Retirement Enhancement (SECURE) Act. This limit has since been increased again as part of SECURE 2.0 Act.

They have 60 days from receiving a distribution to roll it over into their own IRAs as long as the distribution is not a required minimum distribution.

Spousal heirs can also set up a separate inherited IRA account, as described above. How they deal with this IRA depends on the age of the deceased account holder.

If the original owner had already begun receiving RMDs at the time of death, the spousal beneficiary must continue to receive the distributions as calculated or submit a new schedule based on their own life expectancy. If the owner had not yet committed to an RMD schedule or reached their required beginning date (RBD)—the age at which they had to begin RMDs—the beneficiary of the IRA has a five-year window to withdraw the funds, which would then be subject to income taxes.

Inherited IRAs: Rules for Non-Spouses

Non-spouse beneficiaries may not treat an inherited IRA as their own. That is, they may not make additional contributions to the account nor can they transfer inherited funds into their existing IRA account. Non-spouses may not leave assets in the original IRA. They must set up a new inherited IRA account unless they want to distribute the assets immediately via a lump-sum payment.

It is in the realm of distributions that the SECURE Act most drastically affects non-spouse inheritors of IRAs. Previously, these beneficiaries could handle RMDs pretty much as spousal heirs could; in particular, they could recalculate them based on their own life expectancy—which often significantly decreased the annual amount that had to be withdrawn and the tax due on them (in the case of traditional IRAs).

Those who inherit Roth IRAs are required to take distributions (unlike the original account owners), but the funds remain tax-free and also free of any early-withdrawal penalty, even if the beneficiary is under 59½.

No longer. The SECURE Act dictates that, for accounts inherited after Dec. 31, 2019, non-spouse beneficiaries typically must cash out the account within 10 years of the original owner's death. Some heirs are exempted:

  • those whose age is within a decade of the deceased's
  • disabled or chronically ill individuals
  • or minor children; however, these minors must be direct descendants (no grandchildren, in other words), and, once they reach majority age, the 10-year rule kicks in for them too.

There's no particular timetable for the withdrawals; they can be taken annually or all at once. For beneficiaries in these categories and those already in possession of inherited IRAs, the old distribution rules and schedules remain in effect.

Your Options

IRA beneficiaries have several options for claiming their inheritance; however, choices depend on their relationship to the decedent. All beneficiaries have the option to receive a lump sum distribution of the funds or disclaim the inheritance, and depending on the type of account inherited, natural beneficiaries may elect to leave the proceeds in the plan. Spouses have the most options, followed by natural non-spousal beneficiaries. Non-natural beneficiaries have the fewest options.

Spousal Beneficiary

As a spouse inheriting IRA funds, you have the most options for protecting and receiving your inherited funds. You may elect to:

  • Take a lump-sum distribution. Unlike a life insurance policy where death proceeds are non-taxable, IRA distributions are taxable to the beneficiary.
  • Roll over inherited funds into your personal, like-kind IRA. For instance, if you inherit proceeds from your late spouse's Traditional IRA, you may roll over those proceeds to your own Traditional IRA.
  • RMD: Required minimum distributions are based on your age and are calculated using the IRS Uniform Lifetime Table life expectancy factors. The Uniform Lifetime Table factors are based on two lives and are roughly double the factors in the IRS Single Life Expectancy Table; as a result, payments are spread out over a longer period.
  • Transfer the inherited proceeds into an Inherited IRA.
  • RMD: Unlike a Traditional IRA, the timing of the required minimum distribution is based on the decedent's age at the date of death and is calculated using the IRS Single Life Expectancy Table life expectancy factors.
  • Disclaim the proceeds. By not claiming the inheritance, the remaining primary beneficiaries inherit the funds. In the event, other primary beneficiaries are not named with the disclaiming beneficiary, the contingent beneficiaries are eligible to receive the funds. If no beneficiary is named, proceeds are payable to the estate of the decedent or according to contract specifications.

Non-Spousal Beneficiary

Non-spousal beneficiaries include natural persons and non-natural persons. For non-natural persons, such as charities, businesses, trusts, and estates, funds can be distributed as a lump sum or transferred into an Inherited IRA in the name of the beneficiary.

For natural non-spousal beneficiaries, funds can be

  • Taken as a lump-sum distribution, which is taxable to the beneficiary
  • Disclaim the proceeds, transferring full rights to remaining beneficiaries or the decedent's estate.
  • Transfer the inherited funds into their own Inherited IRA
  • RMD: If the original owner passed away before December 31, 2019, the required minimum distribution (RMD) will be based on the beneficiary's age using the single life expectancy factor.
  • RMD: If the original owner passed away before January 1, 2020, the proceeds will be paid out within 10 years from the original owner's date of death. For certain beneficiaries, such as minor children, a disabled or chronically-ill person, or a beneficiary no more than 10 years younger than the deceased, the pre-January 1, 2020 rules apply.

Do Beneficiaries Pay Taxes on Inherited IRAs?

The recipient of an inherited IRA may or may not pay taxes depending on their situation. In general, if you inherit a Roth IRA, you're free of taxes. However, if you inherit a traditional IRA, any amount withdrawn is often subject to taxes. On the other hand, estates subject to the estate tax may also be allowed an income-tax deduction for the estate taxes paid on the IRA.

What Happens When You Inherit an IRA From a Parent?

If a child is not yet of age, a custodian may manage the money in the IRA until the child reaches the state's recognized age of adulthood. Then, at that time, the child would have complete access to the funds. They may choose to withdraw funds from the IRA but depending on the type of account, they may be subject to taxes on withdrawal.

How Do I Avoid Paying Taxes on an Inherited IRA?

Some of the strongest tax-avoidance strategies for an inherited IRA are executed before the original owner passes away. In many cases, it's best for the individual to convert a traditional IRA to a Roth IRA (to potentially minimize the tax burden, especially after their passing). In addition, individuals inheriting IRAs can choose to not take non-qualifying distributions that would otherwise be taxable.

The Bottom Line

Many individuals leverage traditional and Roth IRAs to plan for their retirement. Unfortunately, people may pass away before they make it to retirement age or withdraw all funds from their account. Inherited Roth IRAs often have better tax avoidance capabilities, though those inheriting traditional IRAs will be further constrained. In addition, traditional IRAs will have greater RMD requirements.

Article Sources
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  1. Internal Revenue Service. "Retirement Topics - Beneficiary."

  2. United States Congress. "H.R. 2617."

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