Whether a spouse or non-spouse is named the beneficiary of an individual retirement account (IRA) when the IRA owner dies, the current tax law allows the inheritance, or the total sum in the account, to be accepted tax-free. Beneficiaries of the IRA can also withdraw from the account without penalty at any time.
However, distributions from an inherited IRA are required and each voluntary distribution or required minimum distribution (RMD) from the account will be taxable. Taxation depends on the type of IRA involved and the relationship of the beneficiary to the deceased.
Spouses who inherit an IRA have more flexibility than non-spouse beneficiaries regarding when they must withdraw the funds and deplete the account. One of the important inherited IRA rules for non-spouse beneficiaries is that all money from the account must be withdrawn by December 31st of the 10th year after the original owner’s death.
Key Takeaways
- 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 required minimum distributions.
Types of IRAs
A traditional IRA offers a tax deduction during the years in which contributions are made to the account. The contribution amount is used to reduce the person’s taxable income in the tax year for 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 However, when the money is withdrawn in retirement as a distribution, the amounts are taxed at the individual’s income tax rate in the year of the withdrawal.
If the money is withdrawn before the age of 59½, there’s a 10% tax penalty imposed by the IRS and the distribution would be taxed at the owner’s income tax rate.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 tax year for 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 (RMDs)
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. 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 73, a new age limit established in 2022 under H.R. 2617. However, if you turned 72 before January 1, 2023, you would have needed to begin taking RMDs at age 72, or at 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 25% penalty on the amount you should have—but didn’t—withdraw. However, this penalty can be reduced to 10% if you take the missed distribution within the “correction window.” According to H.R. 2617, this window begins on the date the penalty is imposed, which is usually January 1st after the year you failed to take a distribution. The window ends on the earliest of:
- The date the IRS mails you a notice of deficiency
- The date the IRS assesses the penalty
- The last day of the second taxable year after the penalty is imposed
If you take your RMD before the end of the correction window, your penalty will be reduced to 10%.
The SECURE Act distinguishes an eligible designated beneficiary from other beneficiaries who inherit an account or IRA. Designated beneficiaries, which 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 five years of the employee or IRA owner’s death if distributions have not begun before 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 the age of onset from 70½ to 72. The SECURE Act 2.0 further increased this to age 73.
The SECURE Act also significantly changed some inherited IRA rules for non-spouse beneficiaries. 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 original owner’s death. 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 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
Some beneficiaries are exempted from the 10-year rule. This exemption includes:
- 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 deplete the IRA within 10 years and will likely take annual RMDs from it where the exact amount can be calculated based on their life expectancy.
Beneficiaries have until Dec. 31 of the year following the IRA owner’s death to begin withdrawals. 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, in the amount that the deceased would’ve withdrawn.
Additionally, a surviving spouse beneficiary may delay the commencement of distributions until the end of the year when the original IRA owner would have begun taking RMDs or until the surviving spouse’s required beginning date.
The inheritance rules regarding Roth IRAs can be confusing. A Roth IRA’s original account holder never has to take RMDs, but those who inherit Roth IRAs do unless they fall into one of the exception categories.
Special Rules for Surviving Spouses
Spouses who inherit an IRA have more flexibility than non-spousal beneficiaries regarding when they must withdraw the funds. The spouse can treat the IRA as their own, designating themself as the account owner. The spouse can also roll it over 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 chosen option 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 selecting 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 the owner.
If choosing a rollover, 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 73.
Becoming the owner of the IRA funds can be a good choice if the deceased spouse is 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.
Surviving spouses can parse the account and roll over some of it to their own IRA and leave the balance in the inherited account. If you make a rollover and need funds from it before age 59½, you’ll be subject to the 10% penalty.
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 73, distributions to the spousal beneficiary don’t need to begin until the year in which the original owner reaches age 73. After this, 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 73.
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 that were originally calculated based on the owner’s life expectancy.
The surviving spouse can also submit a new RMD schedule based on their 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).
As a non-spouse with an inherited IRA, you have to set up a new account. The title of the account will conform to tax law, reading: “[Owner’s name], deceased [date of death], IRA FBO [your name], Beneficiary” (FBO means “for the benefit of”). If you put the account in your name, the entire balance is treated as a distribution, and you owe taxes on the lump sum.
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. 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.
Multiple Beneficiaries
If there are multiple beneficiaries, the IRA can be split into separate accounts for each one, a smart choice 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 concerning a decedent is a miscellaneous itemized deduction. You can’t claim it if you use the standard deduction instead of itemizing. It is not subject to the 2%-of-adjusted-gross-income threshold applicable to most other miscellaneous itemized deductions.
What Are the RMDs for an Inherited Roth IRA?
The inheritance rules regarding Roth IRAs can be confusing. A Roth IRA’s original account holder never has to take RMDs, but those who inherit Roth IRAs do unless they fall into one of the exception categories.
Are RMDs Required for Inherited IRAs in 2023?
Yes. Effective beginning tax year 2022, the IRS provided 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 on 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 be taxable. Taxation depends on the type of IRA involved and the relationship of the beneficiary to the deceased.
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. However, there are exceptions to the 10-year rule, and spouses inheriting an IRA have a much broader range of options available to them.
