Inheriting an IRA can be a complex experience, with significant financial and tax implications. The decisions you make now can have long-term consequences for your financial well-being, particularly under the rules introduced by the SECURE 2.0 Act. In this article, I'll guide you through seven key steps for managing an inherited IRA, making sure you stay on the right side of the IRS while maximizing your retirement benefits.
Understanding Inherited IRAs: What You Need to Know
Before diving into the seven steps, let's clarify the scope of this guide:
This guidance is for IRAs inherited after 2020, which means you’re subject to the updated rules under the SECURE 2.0 Act.
The focus is specifically on Inherited IRAs, not other types of retirement accounts like 401(k)s or 403(b)s.
Step 1: Determine the Type of Inherited IRA
The first step is to determine the kind of IRA you've inherited:
Traditional IRA: Withdrawals are taxed as ordinary income.
Roth IRA: Withdrawals are typically tax-free, but there are exceptions.
Tip: If the Roth IRA was less than five years old when you inherited it, you might face taxes on the earnings, though contributions remain tax-free.
Step 2: Identify Your Beneficiary Status
Your relationship to the deceased plays a significant role in what you can do with the inherited IRA. There are three primary categories:
Spouse - You were married to the original account owner.
Eligible Designated Beneficiary (EDB) - This includes minor children, anyone less than 10 years younger than the deceased, or individuals who are chronically ill or disabled.
Non-Eligible Designated Beneficiary (NEDB) - Anyone who doesn’t fit into the first two categories (but was explicitly named as beneficiary on the account).
Step 3: Understand the 10-Year Rule
One of the most important rules under the SECURE 2.0 Act is the 10-year rule, which generally applies to non-eligible designated beneficiaries:
You must empty the entire balance of the IRA within 10 years of the original owner's death.
Eligible beneficiaries can use a "stretch provision," allowing them to take required minimum distributions (RMDs) based on their life expectancy.
Spouses have additional options, such as rolling the inherited IRA into their own, avoiding the 10-year rule altogether.
Step 4: Required Beginning Date (RBD) & RMDs
The Required Beginning Date (RBD) is critical to understanding your obligations. The RBD is the date when the deceased owner was supposed to start taking required minimum distributions:
If the deceased had already started RMDs, you must continue taking them based on your life expectancy.
If they had not reached their RBD, you have more flexibility:
As a spouse, you can delay RMDs until the year the deceased would have turned 72.
Non-eligible beneficiaries must follow the 10-year rule, even if RMDs have begun.
Step 5: How to Calculate Required Minimum Distributions (RMDs)
RMDs are mandatory for all inherited IRAs, including Roth IRAs:
Calculate RMDs by dividing the IRA balance on December 31st of the previous year by a life expectancy factor from the IRS's Single Life Expectancy Table.
If you're a spouse, you might be able to use the Uniform Life Table, which may offer more favorable distribution amounts.
Important: You can't leave funds in a Roth IRA until the final day of the 10th year without taking RMDs. Even Roth inherited IRAs require annual distributions.
Step 6: Rollover and Transfer Options
When it comes to moving an inherited IRA, there are specific rules:
Spouses have the most flexibility:
Roll the IRA into your own account to make it yours, subject to standard IRA rules.
Keep it as an inherited IRA to avoid early withdrawal penalties if you're under 59½.
For non-spouses:
You can't make contributions, perform Roth conversions, or use a 60-day rollover.
You can, however, conduct a trustee-to-trustee transfer if you want to change brokerage firms. Always ensure it's a direct transfer to avoid tax penalties.
Step 7: Designate Your Own Beneficiaries
Don’t overlook the importance of naming beneficiaries for the inherited IRA:
If you pass away without named beneficiaries, the account will go through probate, which can be costly and time-consuming.
Designating beneficiaries ensures a smoother transition and avoids unnecessary legal hurdles.
Key Takeaways for Managing an Inherited IRA
Know your beneficiary category to understand your options.
The 10-year rule is a key component under the SECURE 2.0 Act, especially for non-eligible beneficiaries.
RMDs are required for all inherited IRAs, even Roth IRAs, so understand how to calculate them correctly.
Spouses have unique flexibility compared to other beneficiaries, offering opportunities to minimize penalties and taxes.
Properly designating beneficiaries for your inherited IRA is crucial for a seamless estate transition.
How the SECURE 2.0 Act Impacts Inherited IRAs
The SECURE 2.0 Act introduced significant changes to how inherited IRAs are managed. Here are a few highlights:
The 10-year rule replaced the lifetime "stretch" for most beneficiaries.
There are now stricter RMD requirements for inherited Roth IRAs.
Eligible beneficiaries still have some advantages, such as using the stretch provision for RMDs.
Frequently Asked Questions
Q: Can I still make contributions to an inherited IRA? No, contributions to an inherited IRA are not allowed, regardless of your beneficiary category.
Q: What happens if I miss an RMD? Missing an RMD could result in a significant tax penalty—25% of the amount you should have withdrawn. Under the SECURE 2.0 Act, you may have some leeway to correct the error, but it's best to consult a financial advisor.
Q: How does the 10-year rule affect my tax liability? If you wait until the 10th year to withdraw the entire balance, it could push you into a higher tax bracket. Consider spreading withdrawals across the 10 years to manage tax impact.
Final Thoughts
Inheriting an IRA presents unique opportunities, but it comes with strict guidelines. Understanding these rules—especially the ones introduced by the SECURE 2.0 Act—can help you make informed decisions and avoid costly mistakes. If you’re unsure of your options or need personalized advice, consider consulting with a Certified Financial Planner (CFP).
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About the author
Jake Skelhorn
Jake is a CFP Professional with a focus on planning for both traditional and early retirement. He’s a Florida native, growing up in Fort Lauderdale and now residing in Jacksonville with his husband Chris and their 120-lb “puppy” Barli. Jake enjoys cooking (favorite cuisine to make is Thai), traveling, and spending time with friends and family as much as possible.
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