Understanding Inherited IRAs and the Rules Beneficiaries Must Follow

By Gina Coletti

What happens when you inherit an IRA depends on several factors, including your relationship to the original owner, the type of IRA involved, and in some cases whether the owner had begun taking required minimum distributions.

Those distinctions matter. The SECURE Act and subsequent IRS guidance changed many of the rules governing inherited retirement accounts, particularly for non-spouse beneficiaries. A decision about when to take distributions can also affect your income taxes and the amount that remains invested.

Understanding the rules before taking action can help you avoid an expensive mistake.

What Is an Inherited IRA?

An inherited IRA is a retirement account that passes to a beneficiary after the original account owner dies. It may contain assets from a traditional IRA or Roth IRA, but the beneficiary generally cannot treat the account exactly as the original owner did.

For example, beneficiaries cannot make new contributions to an inherited IRA. How and when money must be withdrawn is governed by specific IRS rules, which vary based on who inherited the account.

This is where inherited IRAs can become complicated. A surviving spouse has options that aren’t available to an adult child or other non-spouse beneficiary. Naming a trust or estate as beneficiary can introduce another set of considerations.

How Does an Inherited IRA Work?

Surviving spouses generally have the greatest flexibility. Depending on the circumstances, a spouse may be able to roll inherited assets into an IRA in their own name or maintain the account as an inherited IRA. Keeping the account separate can sometimes be advantageous for a younger surviving spouse.

Most non-spouse beneficiaries face different rules. They cannot roll an inherited IRA into their own IRA or make new contributions to it. In many cases, they must fully distribute the account within 10 years.

Trusts and estates can also inherit IRAs, but the rules can be considerably more complex. The terms of a trust, the identity of its beneficiaries, and how distributions are structured can affect both the applicable distribution rules and the tax consequences.

What Is the 10-Year Rule for an Inherited IRA?

For many non-spouse beneficiaries, the 10-year rule for inherited IRAs requires the entire account to be distributed by December 31 of the tenth year following the original owner’s death.

That doesn’t necessarily mean a beneficiary can simply wait until year 10. If the original owner died after reaching the point at which required minimum distributions applied, annual RMDs may also be required during the 10-year period.

Certain eligible designated beneficiaries may qualify for different treatment. These can include surviving spouses, disabled or chronically ill beneficiaries, and certain minor children. Depending on the circumstances, distributions may be permitted over the beneficiary’s life expectancy.

A separate five-year rule can apply in more limited situations, including certain accounts without a designated beneficiary. When it applies, the balance generally must be withdrawn by the end of the fifth year following the owner’s death.

What Are the Tax Implications of Inheriting an IRA?

Inheriting an IRA does not necessarily create an immediate income tax bill. Taxes generally become relevant when distributions are taken.

Withdrawals from an inherited traditional IRA are generally taxable as ordinary income. Qualified distributions from an inherited Roth IRA are generally tax-free, although the Roth five-year holding requirement can affect the treatment of earnings.

The timing of withdrawals deserves careful consideration. Suppose you inherit a substantial traditional IRA while you’re still in your peak earning years. Taking the entire balance at once could significantly increase your taxable income. Depending on the rules that apply to the account, spreading distributions across multiple tax years may produce a better result.

The goal isn’t simply to satisfy the inherited IRA rules. It’s to consider those rules alongside your broader tax and financial picture.

What Should You Do With an Inherited IRA?

Before moving or withdrawing money, determine exactly what you’ve inherited and which distribution rules apply. Confirm your beneficiary status with the custodian and establish whether the account is subject to the 10-year rule, five-year rule, life-expectancy distributions, or another exception.

Then consider the timing of distributions in the context of your income, tax bracket, and other financial plans. This can be particularly important with a larger account, where the difference between a planned series of withdrawals and a large distribution in one year can be significant.

Mistakes can be costly. Missing an applicable RMD may result in an excise tax, while improperly combining an inherited IRA with a personal IRA can create additional problems.

Final Thoughts

An inherited IRA can represent years of saving by someone close to you. Managing it thoughtfully means looking beyond the account balance to understand the rules that accompany it.

The right approach depends on who inherited the IRA, the type of account, the applicable distribution timeline, and the beneficiary’s own financial circumstances. For larger inherited accounts in particular, coordinating investment, tax, and estate planning decisions can help preserve more flexibility.

Nixon Peabody Trust Company can help beneficiaries evaluate an inherited IRA within the context of their broader wealth plan and develop a distribution strategy suited to their circumstances.

Frequently Asked Questions

Can I move an inherited IRA into my own account?

Generally, only a surviving spouse has the option to roll inherited IRA assets into an IRA in their own name. Non-spouse beneficiaries typically must maintain the assets as an inherited IRA.

Do I pay taxes when I inherit an IRA?

Generally, inheriting the account itself does not trigger income tax. Traditional IRA distributions are generally taxable as ordinary income, while qualified Roth IRA distributions are generally tax-free.

What happens when you inherit an IRA from a parent?

An adult child is generally treated as a non-spouse beneficiary and, in most cases, will need to fully distribute the inherited IRA within 10 years. Depending on the circumstances, annual RMDs may also be required during that period.

Gina Coletti
Chief Fiduciary Officer
Office: +1 617.345.1110
gcoletti@nixonpeabody.com