Inherited IRA

An Inherited Individual Retirement Account (IRA) is a tax-advantaged savings account that is funded with retirement savings you inherited because someone who has died named you as the beneficiary of his or her traditional IRA or another type of retirement account.

When inheriting retirement savings, federal income tax laws require that you distribute the entire account within a certain amount of time. Each retirement plan or IRA custodian may impose additional distribution requirements on beneficiaries. An Inherited IRA allows you to leave the assets in the IRA to grow tax-deferred for as long as the rules permit. Spreading out your required distributions from the IRA over multiple years can reduce the tax impact of these distributions.

To establish an Inherited IRA, you generally must sign an Inherited IRA plan agreement with an IRA custodian. Banks, life insurance companies, mutual fund companies, brokerage firms and other financial institutions can act as an IRA custodian. The Inherited IRA will be titled to show that you are the beneficiary of the decedent’s retirement savings. The IRA custodian will provide you with a copy of the plan agreement and a disclosure statement that explains the Inherited IRA rules.

Inherited IRAs cannot receive annual IRA contributions. The only assets the Inherited IRA can hold are those you transfer or roll over from an IRA or retirement plan from the same beneficiary. Also, you cannot combine your Inherited IRA with any of your personal IRAs.

You can take distributions from your Inherited IRA at any time, but an early withdrawal penalty may apply. If the distribution is from a traditional Inherited IRA, the distribution will be taxable to you. If it is from a Roth Inherited IRA, the distribution will not be taxable if it is made after a five-year period that begins when the IRA owner first established a Roth IRA. (Withdrawals of contributions from an inherited Roth are tax-free.) Because this is a required distribution following the death of the original owner, the distribution will not be subject to a 10% early distribution penalty, even if you are under age 59½.

When an IRA owner or plan participant dies, you must take distributions within certain timeframes set by federal tax law. (The plan or IRA may be more restrictive.) Your options depend on whether you were married to the account holder (a spouse beneficiary) or not married to the account holder (a non-spouse beneficiary) and whether the individual died before or after the required beginning date for taking required minimum distributions (RMDs).

The required beginning date is April 1 following the year the account owner turns age 73 (the required minimum distribution, or RMD age).

As a surviving spouse and sole beneficiary, you generally have three options upon the IRA owner’s death. You can take distributions under the five-year rule, take life expectancy payments, or treat the individual’s assets as your own IRA. 

(Note: A decision to disclaim IRA assets must be made within 9 months of the original IRA owner's death and before you take possession of the assets.)

Under the 5-year rule, you can take as much or as little as you choose each year, so long as the account is depleted by the end of the year containing the fifth anniversary of the individual’s death.

Under the life expectancy payment option, you must take at least a minimum annual RMD IRA distribution each year. The minimum amount due is calculated by dividing the account balance over your remaining life expectancy as determined by the IRS’s life expectancy tables. You may wait to begin taking these distributions until the year the individual would have reached age 73.

If you choose to treat the assets as your own IRA, you can make contributions and take distributions at will, but you lose the death exception to the 10% early distribution penalty if you are younger than age 59½ when you take distributions. Generally, a designated beneficiary is required to liquidate the account by the end of the 10th year following the year of death of the original IRA owner (this is known as the 10-year rule).

 If the individual died after the required beginning date, the spousal beneficiary may treat the assets as your own or take life expectancy payments based on your life expectancy or the life expectancy of the IRA owner, whichever is longer.

As a non-spouse beneficiary or eligible designated beneficiary, you have two options. You can take distributions under the five-year rule or you can take life expectancy payments.

Under the five-year rule, you can take as much or as little as you choose each year, so long as the account is depleted by the end of the year containing the fifth anniversary of the individual’s death.

Under the life expectancy payment option, you must begin taking at least a minimum distribution each year. The minimum amount due is calculated by dividing the account balance over your remaining life expectancy as determined by the IRS’s life expectancy tables. These payments must begin by December 31 of the year following the year the individual died.

If the individual died after the required beginning date, you must take life expectancy payments based on your life expectancy or the life expectancy of the IRA account owner, whichever is longer.