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Get Familiar With Inherited IRA Rules

Retirement Planning
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Inheriting assets can be a complicated event. On top of the emotional burden of adjusting to life without a loved one, you may also find yourself managing a host of financial logistics. Sometimes, inheriting an individual retirement account (IRA) is part of that journey, and you may want to better understand your next steps and potential options.

Getting familiar with inherited IRA rules is a first step toward navigating your options and making an informed decision. We'll overview some basics of distributions, RMD rules and taxes below.

What Is an Inherited IRA?

The owner of an IRA can choose a beneficiary to take over their account when they die. As the beneficiary, you may be able to cash out the account or keep funds in an IRA. When you choose to keep the money in an IRA, you may continue to enjoy certain benefits, such as the potential for tax-deferred growth on earnings in a traditional account.

Inherited retirement accounts have specific rules. Your options going forward generally depend on your relationship to the person who passed away and the decedent's age at death.

Spousal Beneficiary

When you inherit an IRA from your spouse, you typically have a broader range of options than other types of inheritors, according to the IRS. Here are two popular options:

  1. Treat it as your own: Your first option is to treat the IRA assets as if they were yours. If you take that approach, you are not required to use an inherited IRA. Instead, you can update the decedent's IRA so that it is under your name (assuming the financial institution holding the IRA allows that) or transfer funds directly from your late spouse's IRA into your own IRA.
  2. Use an inherited IRA: If you prefer not to treat the inherited IRA assets as your own, you can move the funds to an inherited IRA just as a non-spouse beneficiary might.

Non-Spouse Beneficiary of an Inherited IRA

If you're not a spousal beneficiary, you have different options available for an inherited IRA. Keeping funds in an IRA may allow you to avoid annual tax reporting on gains in the account and may also enable you to take funds from the account over several years. But if you want to cash out the entire account sooner, you're free to do so (although you may face income taxes and complications as a result of the distribution).

If you're not ready to take the funds immediately, be aware that IRS rules may prevent you from leaving assets in an IRA indefinitely. A non-spouse beneficiary generally will need to remove all funds from an inherited IRA within 10 years after the IRA owner's death. However, you are typically allowed to stretch out payments over a longer period of time if you fall within five categories of individuals considered "eligible designated beneficiaries," as defined by the Internal Revenue Code.

RMD Rules

When you inherit an IRA, you might need to take required minimum distributions (RMDs) from the account each year. It's important to begin that process before December 31 of the year following the account owner's passing — otherwise, you might need to empty the account within 10 years.

Eligible Designated Beneficiary

An eligible designated beneficiary typically has the option of either taking RMDs or removing all funds within 10 years. If the account owner died after their required beginning date of distributions or after April 1 of the year of their 73rd birthday, you can choose the longer of the decedent's life expectancy or your own. If the account owner died before their required beginning date, you can generally take RMDs over your own life expectancy.

Spouse-Inherited IRA

Surviving spouses have greater flexibility in managing RMDs. If you roll inherited IRA assets into your own IRA, RMDs are based on your age and life expectancy. But if you use an inherited IRA instead, RMDs can potentially wait until your spouse would have reached age 72. And if your spouse was taking RMDs at the time of their death, you need to satisfy the RMD for the year of death before moving money into a new account.

Taxes on Inherited IRAs

As a beneficiary, you may wonder if an inherited IRA is taxable. That depends on the type of IRA in question. Distributions from pre-tax retirement accounts are generally taxable. However, distributions from Roth IRAs might not result in federal income taxes if you satisfy all IRS requirements for tax-exempt treatment.

There's also the question of early withdrawal penalties when a beneficiary is under age 59½. Distributions from inherited IRAs are not subject to penalties for early distributions. However, if you roll funds into your own IRA, you might face penalties for early withdrawals.

The Bottom Line

When you inherit an IRA, it can help to identify your options and decide what to do with the assets relatively soon after the account owner dies. That may be difficult as you cope with the loss of a loved one. Inherited IRA rules can be complicated. Discuss your situation with a qualified financial professional. Remember, you may be able to take out more than the RMD in years when you need more money.

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IMPORTANT DISCLOSURES

Securities offered by Registered Representatives through W&S Brokerage Services. Member FINRA/SIPC. All companies are members of Western & Southern Financial Group

Information provided is general and educational in nature. It is not intended to be, and should not be construed as, legal or tax advice. Western & Southern Financial Group and its member companies (“the Company”) does not provide legal or tax advice. Laws of a specific state or laws relevant to a particular situation may affect the applicability, accuracy, or completeness of this information. Federal and state laws and regulations are complex and are subject to change. The Company makes no warranties with regard to the information or results obtained by its use. The Company disclaims any liability arising out of your use of, or reliance on, the information. Consult an attorney or tax advisor regarding your specific legal or tax situation.