If you've recently inherited an IRA, or expect to in the future, it's important to realize how it may affect your taxes and your own retirement account withdrawal rules.
What is an Inherited IRA?
Also known as a "beneficiary IRA," an inherited IRA is an account that's opened for a person who inherits someone else's individual retirement account when that original owner passes. An estate or trust can also be the beneficiary of an inherited IRA.
What Types of IRAs Can Be Inherited?
You can bequeath and, hence, inherit any type of IRA, including a traditional IRA, Roth IRA, SEP IRA or SIMPLE IRA, as long as both the original IRA and inherited IRA are either of the same type or at least have the same treatment for tax purposes.
Rules for Inheriting an IRA
Rules for how to manage an inherited IRA for tax purposes vary depending on whether or not the person inheriting the IRA is the spouse of the deceased original owner.
Rules for Spouses Inheriting an IRA
If you're the spouse of the original owner of the IRA and its sole beneficiary, the IRS will treat the inherited IRA as though it had belonged to you all along. This is known as "assuming" an IRA or a "spousal transfer."
In this instance, you have several ways to handle the inherited account. You can either declare yourself the existing account's owner, set up a brand new account for the inherited IRA or roll it into your existing retirement account. In order to roll an inherited IRA into your own existing retirement account, be it an IRA or a qualified employer plan, like a 403(b), both accounts, again, must have the same tax treatment.
Rules for Non-spouses Inheriting an IRA
If you're not the spouse of the IRA's original owner, there are a few extra steps you must perform to meet IRS and IRA requirements. Whether a single individual or a group of individuals, any non-spouse entities inheriting an IRA must set up a new IRA named as a beneficiary IRA, such as "(Deceased Owner's Name) for the Benefit of (Inheritor's Name.)" You must then, as an inheriting non-spouse, transfer some portion of your assets into that new account. From that point forward, you may not make any additional contributions to that account.
Distribution Rules on Inherited IRAs
Prior to 2020, anyone who inherited an IRA could take distributions from that account at will over their entire lifetime. However, those rules became a little more complicated.
Following passage of the Secure Act into law, effective December 31, 2019 any beneficiary of an inherited IRA must deplete those funds within 10 years of the original owner's death.
Within that limitation, you have the freedom and flexibility to take that money out over as many or as few withdrawals as you want of whatever portion of the remaining funds you want. That means you can take it all out the moment the transfer is complete, you can wait the full 10 years and then take it all out in one lump sum, or you can spread it out over multiple withdrawals over that time frame.
Note, however, that, if the account is a traditional IRA, the IRS will consider each distribution as taxable income for the year in which you take that distribution.
Exceptions to Inherited IRA Distribution Rules
Some exceptions do exist to the aforementioned distribution rules.
If you're the spouse of the original owner, the IRS treats your inherited IRA as your own account, subject to the same limitations and liberties of a personal IRA. If the account is a Roth IRA, you need not take any distributions in your lifetime, thereby allowing you to then bequeath that account to some other beneficiary or beneficiaries of your choosing. If the account is Traditional IRA, however, you must start taking required regular distributions at age 72, if you haven't already started earlier. Either way, you thereafter have your entire lifetime over which to spread out those distributions, known as the "stretch option," if you choose.
Note that, if the original owner was required to take a required minimum distribution (RMD) from that account the year of his or her death and had not done so by the time of his or her death, you are, then, responsible for fulfilling that obligation. Failing to do so could expose you to a penalty of 50% of the portion of the RMD not withdrawn in time. The deadline for taking a RMD any given year is the final day of the calendar year. No year-of-death requirement exists if the original owner took his or her RMD that year or was not required to take one.
Another exception to inherited IRA rules applies to minor children of the deceased. In such cases, distributions must begin immediately based on each child's life expectancy. This must continue until the child reaches age 18, at which point the now-adult has 10 years to deplete the remaining funds in the account.
If you're disabled or chronically ill when you inherit an IRA, you also have the stretch option to spread out distributions over your lifetime. The same applies if you're less than 10 years younger than the original accountholder.
How the 5-year Rule Applies to Inherited IRAs
Generally, the holder of a Roth IRA can withdraw contributions at any time without paying taxes on those funds, but any earnings on those funds withdrawn from a Roth IRA are taxable, unless the account has been open for at least five years.
In the case of an inherited IRA, the same flexibility applies to contributions, but, to withdraw any earnings on those funds from an inherited IRA, the original account must have been open for at least five years prior to the original owner's death. Otherwise, you must pay taxes on any earnings you withdraw from that inherited account.
Where to Find Charlotte Tax Accountants to Help With an Inherited IRA
Navigating an inherited IRA can be a juggling act between financial planning, tax planning and estate planning, and the worst thing you can do is try to manage it on your own. That's why, before you take any action regarding an inherited IRA, make sure you seek out the professional guidance of a licensed and properly trained tax accountant.
Running one of the top accounting firms in Charlotte NC, Scott Boyar can help you understand how inheriting an IRA may affect your specific tax, retirement and estate planning circumstances. Scott is like the neighborhood tax advisor Charlotte NC residents grew up with, offering his wealth of financial guidance in plain, simple and down-to-earth language. You don't even need to visit his office in person to consult with Scott Boyar, as he also offers services as a remote CPA in Charlotte.
If you've been researching Charlotte tax accountants to help you navigate inheriting an IRA, give Scott Boyar a call at (704) 527-2725 or contact him online at sboyarcpa.com/contactus. Chances are you'll agree with so many before you that he's the only accountant Charlotte NC residents need.