When you are named the beneficiary of an individual retirement account (IRA), and the IRA owner dies, you may think you've received a tax-free inheritance. Well, that's only partially correct. Under current tax law, the inheritance itself—that is, the entire sum in the account—is tax-free. But you are still required to take distributions from the account, which may well be taxable. Taxation depends on the type of IRA involved and the relationship of the beneficiary to the deceased.
When you inherit an IRA, you are free to withdraw without penalty as much of the account as you want at any time. However, it's important to be aware of any potential income tax implications for when you withdraw money from an inherited IRA. Also, there are distinct differences in the rules for withdrawing money, depending on whether you're the deceased owner's spouse or you're a non-spousal beneficiary of the IRA.
- Individual retirement account assets are passed to the named beneficiaries, often the person's spouse, upon death.
- Non-spousal beneficiaries must withdraw all funds from an inherited IRA within 10 years of the original owner's death.
- Spousal IRA beneficiaries have different rules and more options to consider when taking their RMDs.
First, a quick refresher on IRAs and how withdrawals from them work.
Types of IRAs
There are various types of IRAs. A traditional IRA offers a tax deduction in the years that the contributions are made to the account. In other words, the contribution amount is used to reduce the person's taxable income in the tax year in which the contribution was made.
You can also make contributions that are not tax-deductible. IRAs also grow tax-deferred, meaning the earnings and interest over the years are not taxed. However, when the money is withdrawn in retirement—called a distribution—the amounts are taxed at the individual's income tax rate in the year of the withdrawal.
If the money is withdrawn before the age of 59½, there's a 10% tax penalty imposed by the IRS and the distribution would be taxed at the owner's income tax rate. If you inherit a traditional IRA to which both deductible and nondeductible contributions were made, part of each distribution is taxable.
A Roth IRA doesn't offer an upfront tax deduction like traditional IRAs, but withdrawals from a Roth are tax-free in retirement. If you inherit a Roth IRA, it is completely tax-free if the Roth IRA was held for at least five years (starting Jan. 1 of the year in which the first Roth IRA contribution was made).
If you receive distributions from the Roth IRA before the end of the five-year holding period, they are tax-free to the extent that they represent a recovery of the owner's contributions. However, any earnings or interest on the contribution amounts is taxable.
Required minimum distributions
The IRS has established a minimum amount that account-holders must withdraw from an IRA (and defined-contribution plans, such as 401(k) plans) each year. These mandatory withdrawals are called required minimum distributions (RMDs). RMDs are designed to eventually exhaust the funds in the account so that the accumulations won't last forever (and the IRS eventually gets its cut of some of the funds). RMDs apply to traditional IRAs. Roth IRAs don't require RMDs.
Typically, if you own a traditional IRA, you must begin your distributions when you reach age 72 (or 70½ if you hit that milestone before Jan. 1, 2020). All RMD withdrawals will be included in your taxable income except for any portion that was taxed earlier—say, if you made a contribution to the account with after-tax dollars. If you fail to take your RMD, you can be subject to a whopping 50% penalty on the amount you should have—but didn't—withdraw.
The SECURE Act distinguishes between an eligible designated beneficiary and other beneficiaries who inherit an account or IRA. Designated beneficiaries, who are not eligible designated beneficiaries, must withdraw the entire IRA by the 10th calendar year following the year of the employee or IRA owner’s post-2019 death. Non-designated beneficiaries must withdraw the entire account within 5 years of the employee or IRA owner’s death if distributions have not begun prior to death.
The SECURE Act and Inherited IRAs
The Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act) made major changes to IRA RMD rules—pushing back the age of onset from 70½ to 72.
It also significantly changed some rules regarding inherited IRAs. Starting with those inherited after Jan. 1, 2020, the SECURE Act requires the entire balance of the participant's inherited IRA account to be distributed or withdrawn within 10 years of the death of the original owner. The 10-year rule applies regardless of whether the participant dies before, on, or after, the required beginning date (RBD)—the age at which they had to begin RMDs.
In other words, you must withdraw the inherited funds within 10 years and pay income taxes on the distributed amounts. Since the withdrawals are required, you won't pay the 10% penalty if you're under the age of 59½. But you must pay income taxes on the distributions, and you must eventually empty the account.
Exceptions to the 10-year rule
However, there are exceptions to the 10-year rule for certain types of beneficiaries:
- a surviving spouse
- a disabled or chronically ill person
- a child who hasn't reached the age of majority
- a person not more than 10 years younger than the IRA account owner
These beneficiaries are not obligated to empty the IRA. But unless they can treat the account as their own (see "Special Rules for Surviving Spouses," below), they do have to take annual RMDs from it; the exact amount can be calculated based on their own life expectancy.
Generally, they have until Dec. 31 of the year following the IRA owner's death to start doing so. However, if the original account owner was required to take an RMD in the year they died but hadn't yet, the beneficiary is required to take that RMD for them in that year—and of the amount the deceased would've withdrawn. Additionally, a surviving spouse beneficiary may delay commencement of distributions until the later of the end of the year that the employee or IRA owner would have attained age 72, or the surviving spouse’s required beginning date.
The inheritance rules regarding Roth IRAs can be especially confusing. In a nutshell, a Roth's original account-holder never has to take RMDs. Those who inherit Roth IRAs do, however—unless they fall into one of the exception categories, like being a minor child. However, these minors must be direct descendants (no grandchildren, in other words) and, once they reach majority age, the 10-year rule for emptying the account kicks in for them too.
Special Rules for Surviving Spouses
Spouses who inherit an IRA have more flexibility than non-spousal beneficiaries in regards to when they must withdraw the funds. The surviving spouse typically has a few choices. The spouse can treat the IRA as their own, designating themself as the account owner. The spouse can also roll it over (transfer the funds) into their own, pre-existing IRA. Finally, they can treat themselves as the account beneficiary.
The choice is usually based on when the spouse is due to take their RMDs or whether the deceased owner was taking their RMDs or not, at the time of their death. The option that's chosen can impact the size of the required minimum distributions from the inherited funds and, as a result, have income tax implications for the spousal beneficiary.
Surviving spouse becomes the IRA owner
If you are the surviving spouse and sole beneficiary of your deceased spouse's IRA, you can elect to be treated as the owner of the IRA and not as the beneficiary. By electing to be treated as the owner, you determine the required minimum distribution as if you were the owner beginning with the year you elect or are considered to be the owner.
Spousal beneficiaries also have the option to roll over the inherited IRA funds, or a portion of the funds, into their existing individual retirement account. Spouses have 60 days from receiving the inherited distribution to roll it over into their own IRA as long as the distribution is not a required minimum distribution. By combining the funds, the spouse doesn't need to take a required minimum distribution until they reach the age of 72.
Becoming the owner of the IRA funds can be a good choice if the deceased spouse was older than the spousal beneficiary because it delays the RMDs. If the IRA was a Roth, and you are the spouse, you can treat it as if it had been your own Roth all along, in which case you won't be subject to RMDs during your lifetime.
However, this is not an all-or-nothing decision. You can parse the account and roll over some of it to your own IRA and leave the balance in the account you inherited, but there's no changing your mind. If you make a rollover and need funds from it before age 59½, you'll be subject to the 10% penalty (unless some penalty exception other than death applies).
Surviving spouse acts as the beneficiary
RMDs are based on the life expectancy of the IRA owner. Spousal beneficiaries can plan the RMDs from an inherited IRA to take advantage of delaying the RMDs as long as possible.
If the IRA owner dies before the year in which they reach age 72, distributions to the spousal beneficiary don't need to begin until the year in which the original owner reaches age 72. After which, the surviving spouse's RMDs can be calculated based on their life expectancy. This can be helpful if the surviving spouse is older than the deceased spouse since it delays RMDs from the inherited funds until the deceased spouse would have turned age 72.
If the original owner had already started getting RMDs or reached their required beginning date (RBD)—the age at which they had to begin RMDs, at the time of death, the spouse can continue the distributions as were originally calculated based on the owner's life expectancy.
Please note that the RMD rules for beneficiaries do not eliminate the need for the deceased owner’s estate to take his or her RMD for the year of death if the owner died on or after attaining age 72. The RMD for the owner reduces the account value on which the RMD for the beneficiary is figured.
However, the surviving spouse can also submit a new RMD schedule based on their own life expectancy. This process would mean applying the life expectancy for their age found in the Single Life Expectancy Table (Table I in Appendix B of IRS Publication 590-B).
Ideally, spousal beneficiaries want to use the longer single life expectancy, so that the annual RMDs are smaller, resulting in a delay in paying taxes on the inherited IRA funds for as long as possible. Remember, you can always withdraw more money than the required minimum distribution, if you need the funds.
If you are not a spouse and are bequeathed an IRA, you have to set up a new account, which is technically known as an inherited IRA. Make sure that the title of this new account conforms to tax law. The account title should read: "[Owner’s name], deceased [date of death], IRA FBO [your name], Beneficiary" (FBO means "for the benefit of"). Do not put the account in your own name—if you do, the entire balance is treated as a distribution, and you owe taxes on the lump sum. It's very difficult to undo this error.
Special IRA Transfer Rule
You can transfer up to $100,000 from an IRA directly to a qualified charity. The transfer, which is called a qualified charitable distribution (QCD) even though no tax deduction is allowed, is tax-free and can include RMDs (i.e., they become non-taxed). In other words, the transfer can satisfy your RMD for the year up to $100,000 and you're not taxed on the amount. This tax break was made permanent by the Consolidated Appropriations Act of 2016, which became law on Dec. 18, 2015.
If there are multiple beneficiaries, the IRA can be split into separate accounts for each one (a good move if one beneficiary is a non-spouse, subject to the 10-year rule, and the other is a spouse or in one of the other special categories).
If you want to split the IRA, you must do so by Dec. 31 the year following the year of the original owner's death.
Handling Tax Issues
When taking RMDs from a traditional IRA, you will have income taxes to report. You'll receive Form 1099-R showing the amount of the distribution. You must then report in on your Form 1040 or 1040A for the year.
If the distribution is sizable, you may need to adjust your wage withholding or pay estimated taxes to account for the tax that you’ll owe on the RMDs. These distributions, which are called nonperiodic distributions, are subject to an automatic 10% withholding unless you opt for no withholding by filing Form W-4P.
If the IRA owner died with a large estate on which federal estate taxes were paid, as the beneficiary you are entitled to a tax deduction for the share of these taxes allocable to the IRA.
The federal income tax deduction for federal estate tax on income with respect to a decedent (such as an IRA) is a miscellaneous itemized deduction. (You can’t claim it if you use the standard deduction instead of itemizing.) Still, it is not subject to the 2%-of-adjusted-gross-income threshold applicable to most other miscellaneous itemized deductions.
However, please check with the custodian or trustee of the IRA for the amount and timing of your RMDs. Also, please consult a knowledgeable tax advisor to ensure that you meet the RMD requirements and the applicable tax laws.
What Are the RMDs for an Inherited Roth IRA?
The inheritance rules regarding Roth IRAs can be especially confusing. In a nutshell, a Roth's original account-holder never has to take RMDs. Those who inherit Roth IRAs do, however—unless they fall into one of the exception categories, like being a minor child. However, these minors must be direct descendants (no grandchildren, in other words), and, once they reach majority age, the 10-year rule for emptying the account kicks in for them too.
Are RMDs Required for Inherited IRAs in 2022?
Yes. Effective this year, the IRS provides new life expectancy tables to calculate required minimum distributions from retirement accounts. The updated data reflects the fact that people are living longer.
What Is the 10-Year Distribution Rule for Inherited IRA?
The SECURE act changed the RMDs for inherited IRAs. Under the 10-year rule, the value of the inherited IRA needs to be zero by Dec. 31 of the 10th anniversary of the owner's death.
The Bottom Line
If you inherit an IRA, you are generally required to take distributions from the account, which may well be taxable. Taxation depends on the type of IRA involved and the relationship of the beneficiary to the deceased.
Starting with those inherited after Jan. 1, 2020, the SECURE Act requires the entire balance of the participant's inherited IRA account to be distributed or withdrawn within 10 years of the death of the original owner. The 10-year rule applies regardless of whether the participant dies before, on, or after the required beginning date (RBD)—the age at which they had to begin RMDs.
However, there are exceptions to the 10-year rule, and spouses inheriting an IRA have a much broader range of options available to them. The spouse can treat the IRA as their own, designating themself as the account owner. The spouse can also roll it over (transfer the funds) into their own pre-existing IRA. Finally, they can treat themselves as the account beneficiary.