How do IRS rules apply to Inherited IRAs?

An Inherited IRA is an individual retirement account that you inherit from a deceased account holder. The IRS has specific rules for Inherited IRAs to ensure that beneficiaries comply with tax laws and understand their required distributions. The rules for Inherited IRAs depend on several factors, including the type of beneficiary (spouse or non-spouse), the age of the deceased account holder, and whether the IRA is a traditional or Roth IRA.

1. Who Can Inherit an IRA?

• Spouse Beneficiaries: If you inherit an IRA from your spouse, you have several options for managing the account:
  • Treat as Your Own: You can treat the inherited IRA as your own by transferring the assets into your existing IRA or creating a new IRA in your name.
  • Spousal Rollover: You may roll over the inherited IRA into your own IRA. This would allow you to take distributions based on your age and avoid required minimum distributions (RMDs) until you reach 73 (if applicable).
  • Beneficiary IRA: If you don’t roll over the IRA, you can keep it as a beneficiary IRA. However, you’ll have to take distributions from the account, typically based on the deceased spouse’s age.
• Non-Spouse Beneficiaries: Non-spouse beneficiaries (such as children or siblings) cannot treat the IRA as their own. They must set up an Inherited IRA in their name and take RMDs. The rules for RMDs differ depending on the decedent's age at death.

2. Key IRS Rules for Inherited IRAs

The IRS requires beneficiaries of Inherited IRAs to begin taking required minimum distributions (RMDs) from the inherited account. The specific rules vary depending on several factors:

• The SECURE Act (2019): This law significantly changed the rules for non-spouse beneficiaries of IRAs. Under the SECURE Act, most non-spouse beneficiaries are required to withdraw the entire balance of the inherited IRA within 10 years of the account holder’s death, with some exceptions.

• Exceptions to the 10-Year Rule: Certain beneficiaries are allowed to stretch RMDs over their lifetime, including:

  • Surviving spouses
  • Minor children of the decedent (until they reach the age of majority)
  • Disabled or chronically ill beneficiaries
  • Beneficiaries who are not more than 10 years younger than the decedent

3. Required Minimum Distributions (RMDs)

• Spouse Beneficiaries: If you are the spouse beneficiary and you treat the IRA as your own, you don’t need to take RMDs until you reach the age of 73. If you keep the IRA as an inherited account, you’ll follow the rules for non-spouse beneficiaries and take distributions according to the IRS tables.

• Non-Spouse Beneficiaries: Non-spouse beneficiaries are required to begin taking RMDs by December 31 of the year following the original account holder's death. The amount of the RMD depends on the beneficiary’s life expectancy, the decedent’s age, and the account balance.

• 10-Year Rule: As mentioned earlier, most beneficiaries must empty the IRA within 10 years, which can lead to large tax bills if the distributions are not carefully planned. However, there are no annual distribution requirements, as long as the full amount is distributed within the 10-year period.

4. Tax Implications

• Traditional IRAs: Withdrawals from a traditional Inherited IRA are taxed as ordinary income. The beneficiary will pay taxes on any distributions taken from the account.

• Roth IRAs: Distributions from an Inherited Roth IRA are generally tax-free, provided the account has been open for at least 5 years. If the Roth IRA has not met the 5-year holding period, distributions may be subject to taxes on the earnings but not on the contributions.

5. Example Scenarios

• Example 1: Spouse Beneficiary Sarah inherits a traditional IRA from her deceased husband, John. She decides to roll the account into her own IRA and treats the inherited IRA as her own. She won’t need to take any RMDs until she reaches age 73, based on her life expectancy.

• Example 2: Non-Spouse Beneficiary Mike inherits an IRA from his aunt, Nancy. Under the SECURE Act, Mike must empty the IRA within 10 years. He can take distributions in any amount and at any time within the 10-year period, but the entire balance must be distributed by the end of the 10th year following Nancy’s death.

6. Resources and Official IRS Links

To learn more about the IRS rules on Inherited IRAs, you can refer to the following official IRS publications and tools:

• IRS Publication 590-B: This publication provides detailed information on Required Minimum Distributions (RMDs) from IRAs, including the rules for Inherited IRAs.
• IRS FAQs on Inherited IRAs: This page answers common questions about tax implications and distribution rules for Inherited IRAs.
• The SECURE Act Summary: This legislation changed the distribution rules for non-spouse beneficiaries of IRAs, so it's crucial for anyone inheriting an IRA to be familiar with it.

7. Final Thoughts

Inheriting an IRA comes with responsibilities, especially regarding required distributions. Understanding the IRS rules and ensuring that you take the appropriate actions can help you avoid costly penalties and taxes. Always consult a financial advisor or tax professional when inheriting an IRA to make sure you comply with the applicable rules and regulations.