An Inherited Individual Retirement Account (IRA) is a retirement account that a beneficiary inherits upon the account owner’s death. These accounts come with specific rules and tax implications that can differ significantly based on whether the beneficiary is a spouse or a non-spouse.
Definition of Inherited IRA
An inherited IRA, sometimes referred to as a beneficiary IRA, is an account set up for someone who inherits an IRA or employer-sponsored retirement plan following the original owner’s death. The inherited IRA remains tax-deferred, and the beneficiary must adhere to required minimum distributions (RMDs).
Types of Inherited IRAs
Spousal Beneficiary
A spousal beneficiary has the unique option to treat the inherited IRA as their own. This means the surviving spouse can roll over the assets into their own IRA or elect to continue the account under their name using the same tax treatment as their existing IRAs.
Non-Spousal Beneficiary
Non-spousal beneficiaries have stricter rules. They cannot treat the IRA as their own and must generally begin taking RMDs according to the IRS’s distribution rules, typically within a set period.
Tax Rules for Inherited IRAs
General Tax Implications
Inherited IRAs maintain the tax-advantaged status of the original account. Taxes are generally deferred until distributions are taken. However, the timing and amounts of distributions can significantly affect the taxes owed.
Tax Rules for Spousal Beneficiaries
Spouses have flexible options:
- Roll Over: They may roll the inherited IRA into their own IRA. This option allows the spouse to treat it as their own and delay RMDs until they reach age 73 (as of 2023 regulation).
- Inherited IRA: They can treat the IRA as an inherited account, which may be beneficial if the surviving spouse is younger than 59½ and might need penalty-free access to funds.
Tax Rules for Non-Spousal Beneficiaries
Non-spousal beneficiaries must follow specific timelines:
- 10-Year Rule: The SECURE Act of 2019 stipulates that most non-spouse beneficiaries must withdraw the entire balance of the inherited IRA within ten years of the original owner’s death.
- Five-Year Rule (Pre-SECURE Act): For some deaths prior to 2020, beneficiaries may have had to withdraw all funds within five years.
Strategy Considerations
Factors for Spousal Beneficiaries
Spouses should consider their current financial situation, tax bracket, and retirement plan to make the best use of the inherited IRA funds.
Factors for Non-Spousal Beneficiaries
Non-spousal beneficiaries must strategize to manage tax liabilities, considering how distributions affect their income and tax bracket.
Historical Context
The rules governing inherited IRAs have evolved, most recently with the passage of the SECURE Act in 2019, which fundamentally changed distribution requirements for non-spouse beneficiaries. Previously, beneficiaries could stretch out distributions over their lifetimes, but now most must adhere to the ten-year rule.
Applicability and Examples
Example for Spousal Beneficiaries
Mary inherits her husband John’s traditional IRA. At 60, she rolls over John’s IRA into her own, deferring distributions until she retires at 65, allowing the funds to grow tax-deferred.
Example for Non-Spousal Beneficiaries
Tom, a non-spousal beneficiary, inherits a traditional IRA from his brother in 2021 and must withdraw the entire amount by 2031, potentially creating considerable taxable income each year until then.
Related Terms
- Required Minimum Distributions (RMDs): The amount that must be withdrawn annually from most retirement accounts starting at age 73.
- SECURE Act: The Setting Every Community Up for Retirement Enhancement Act of 2019, which changed many retirement account rules.
FAQs
Can non-spousal beneficiaries roll over inherited IRAs into their own IRAs?
What happens if a beneficiary does not take the required distributions?
References
- Internal Revenue Service. (2023). “Publication 590-B: Distributions from Individual Retirement Accounts (IRAs).”
- U.S. Congress. (2019). “SECURE Act of 2019.”
Summary
Inherited IRAs provide continued tax advantages for beneficiaries but come with complex rules based on the beneficiary’s relationship to the deceased. Spouses have flexible options, while non-spousal beneficiaries must adhere to more rigid withdrawal rules. Understanding these distinctions and the tax implications can aid beneficiaries in managing inherited accounts effectively.
