An inherited IRA can play a key role in estate planning, and you can also decide how much of the account each beneficiary receives. Here’s what you need to know about inherited IRAs and how to plan for the future.

What Is an Inherited IRA?

An inherited IRA, or beneficiary IRA, is an account that passes to a designated beneficiary when the original IRA owner dies without fully withdrawing their balance. If you don’t name a specific beneficiary, your estate will inherit the account, and a representative of your estate will determine who receives portions of the IRA.

When you contribute to a Roth IRA, you can assign multiple beneficiaries and decide how much each beneficiary will inherit. Different retirement plans may have unique rules for beneficiary designations, so it’s essential to follow your plan’s procedures. In some cases, certain beneficiaries, like spouses or children, may need to be designated.

Generally, beneficiaries of an inherited IRA can choose to take a lump-sum distribution whenever they wish.

IRS Rules & Tax Implications for Inherited IRAs

Designating a beneficiary and understanding the related rules can help ensure your loved ones are prepared financially. When inheriting an IRA, beneficiaries must follow IRS regulations, which may include required minimum distributions (RMDs) and applicable taxes on withdrawals.

Who Can Be an IRA Beneficiary?

Anyone can be named as an IRA beneficiary. However, the rules for handling an inherited IRA vary based on whether the individual qualifies as an “eligible designated beneficiary” or a “designated beneficiary.”

Eligible designated beneficiaries include:

• Spouses
• Minor children
• Disabled or chronically ill individuals
• Those within 10 years of age of the IRA owner

In contrast, a designated beneficiary refers to anyone else named to inherit the IRA. Eligible designated beneficiaries may take distributions based on either their life expectancy or the original account holder’s life expectancy. They may also choose the 10-year rule if the account owner died before their RMD date.

Do RMDs Apply to Inherited IRAs?

In most cases, inherited retirement accounts still require RMDs. The specifics depend on:

• The age of the account owner at death
• The date of death
• The relationship between the account owner and the beneficiary

If the account owner passed away before starting RMDs, spouses can either follow the five-year rule (emptying the account by the fifth year following the year of death) or base distributions on their life expectancy. They can also roll the inherited IRA into their own IRA.

Inherited IRA Rules for Spouses vs. Nonspouses

For account holders who died in 2020 or later, spouses have several options if the owner died before starting RMDs:

• Delay RMDs until the account owner would have turned 73
• Take distributions based on their life expectancy
• Follow the 10-year rule
• Roll the account into their own IRA

If the account holder died after the RMD start date, spouses must take distributions based on their life expectancy or roll the IRA into their own account. Nonspouse beneficiaries can use the five-year rule or their life expectancy if they qualify as an eligible designated beneficiary under the current rules.

Roth IRA beneficiaries must also follow specific Roth rules. If you’re uncertain about handling an inherited IRA, consulting a tax expert or attorney can be helpful.

The SECURE Act & Its Impact on Inherited IRAs

The SECURE Act, enacted in 2019, made changes to retirement savings rules to aid individuals in planning for retirement. For inherited IRAs, the SECURE Act’s distribution rules apply only to accounts inherited after January 1, 2020, while accounts inherited before this date follow previous RMD rules.

The act expands options for those who inherit IRAs, including nonspouse beneficiaries. Eligible designated beneficiaries can choose to take distributions over the life expectancy of either themselves or the original account owner. Alternatively, they can opt for the 10-year rule, requiring that the entire balance be distributed within 10 years.

If the account owner’s death occurred before the SECURE Act, beneficiaries must follow the five-year rule, which requires distributions within five years.

The SECURE 2.0 Act

The SECURE 2.0 Act, effective in 2023, raised the RMD age to 73, allowing individuals more time to grow their retirement savings before mandatory withdrawals begin.

Managing Your Inherited IRA: Options & Strategies

Selecting a beneficiary for your IRA is an important step in simplifying account management for your heirs. It’s also helpful in streamlining the RMD process when the account is inherited.

If the beneficiary is not an individual, different rules apply. Working with a financial advisor can help you make these decisions and ensure your loved ones are prepared for future needs.

Traditional vs. Roth Inherited IRAs

Traditional IRAs are funded with pre-tax dollars, meaning distributions are taxed. Roth IRAs, funded with post-tax dollars, generally allow tax-free withdrawals.

The same tax implications apply to inherited IRAs. With a traditional IRA, distributions are taxed as part of gross income. For Roth IRAs, withdrawals are generally tax-free since the funds have already been taxed.

If you’re unsure whether a traditional or Roth IRA is better for your retirement plan, consulting a financial advisor can help you evaluate your options. Each account type has advantages that can support your financial goals.

PSA CPA is here to help ensure your tax strategy aligns with the choices you made over the past year, helping you make the most of your investments and maximize your tax benefits.