Inherited IRA Options: What Heirs Need to Know
By Marjorie L. Rand, CPA, CFP®, RICP®
Since IRAs were introduced in 1974, they’ve grown into a favored way to save for retirement. Known for their tax advantages and independence from employer plans, IRAs often get media spotlight for contributions and growth. However, what happens to an IRA after the owner passes away is less frequently discussed. If you’ve inherited an IRA, understanding your inherited IRA options is crucial to making informed decisions that align with your financial goals.
Spousal Inheritance
If you inherit an IRA from your spouse, you can simply roll over the money into your own like-kind IRA account (traditional IRA or Roth IRA). In such cases, there is no taxable event, and your former spouse’s money is thereafter treated as your own. All the same rules will apply as if it were always your money, including required minimum distributions (RMDs).
Lump-Sum Option
An option available to all heirs, regardless of relationship, is to simply cash out the account. You can take the money in a single lump sum penalty-free. However, you may have to pay income taxes depending on whether the contributions were made pre- or post-tax. Receiving a large sum that counts as income for tax purposes may push you into a higher tax bracket.
New Inherited IRA Rules
Recent changes to the IRS regulations, finalized and effective July 19, 2024, could impact your inheritance. The ability to stretch out IRA distributions over time—a key tax advantage—has been removed by the SECURE Act of 2019. As a result, more of the inherited funds may be lost to taxes, reducing the amount your loved one intended for you. SECURE 2.0 modified the new rule, but also raised the initial RMD age to 73 (increasing to 75 in 2033).
The revised 10-year rule applies to non-spousal beneficiaries of IRAs inherited after January 1, 2020. Funds must be withdrawn within 10 years of the benefactor’s death, with certain exceptions for eligible designated beneficiaries like spouses, minors, and disabled individuals. In addition, if the original (now deceased) owner of a traditional or rollover IRA (not Roth) had been taking their regular RMDs while alive, the beneficiary(s) are also required each year to withdraw a minimum amount based upon their own expected life expectancy, with the entire inherited IRA still fully distributed by year 10. Penalties for missed distributions between 2021-2024 were waived, but beneficiaries must start RMDs by 2025.
Inherited Roth IRAs are also subject to the 10-year distribution rule but don’t require annual RMDs during the first 9 years, unlike traditional IRAs. Inherited Roth IRAs must be fully distributed by year 10, but the distributions have no impact on the beneficiary’s tax situation.
Inherited IRA As a Wealth Transfer Method
IRAs aren’t required to pass to spouses at death. The account owner can designate any beneficiary that he or she chooses. Because of this, some families use IRAs as a powerful wealth transfer method.
If an account owner knows that his or her spouse will not need the money, they can designate another relative as the beneficiary. The younger the beneficiary, the longer the money will have to grow (after the 10-year distribution has finished and any applicable taxes paid) for the beneficiary’s future needs. Many people who already have secure retirements for their spouses designate grandchildren as IRA beneficiaries so that they can pass on an inheritance that will eventually continue to grow for many years.
This is only possible for the beneficiaries of the original account owner. If the beneficiaries die and pass on the account, the subsequent beneficiaries must take RMDs based on the original beneficiary’s life expectancy.
Which Inherited IRA Options Fit Your Needs?
IRA regulations have become surprisingly intricate, and managing substantial funds in an IRA or inherited IRA involves navigating a range of rules and potential tax consequences. The right approach can vary significantly based on the type of IRA and your unique financial situation.
As both a CERTIFIED FINANCIAL PLANNER™ professional and a CPA, I bring a comprehensive perspective that blends financial planning with in-depth tax knowledge. This dual expertise allows me to look at the full picture, helping clients and their families make informed decisions about their inherited IRAs and broader financial lives.
If you’d like to explore whether we’re a good fit to work together, I invite you to schedule a 20-minute introductory call. You can reach me directly at 908-895-2406 or marge@randfinancialplanning.com.
About Marge
Marjorie Rand is founder and financial advisor at Rand Financial Planning, a comprehensive, fee-only, fiduciary financial planning firm based in Flemington, New Jersey. Marge specializes in helping her clients plan for a secure retirement and navigate life’s many transitions through customized, tax-efficient retirement planning. She is passionate about empowering her clients to make the best financial decisions for their life and being by their side no matter what life throws at them. Marjorie spent many years as a CPA, specializing in estates, before founding Rand Financial Planning so she could be a go-to source for all her clients’ financial needs and help them avoid costly mistakes. She has a bachelor’s degree in accounting from Rutgers University and a Master of Science in Taxation from Fairleigh Dickinson University, along with the Retirement Income Certified Professional® (RICP®) and CERTIFIED FINANCIAL PLANNER® certifications. When she’s not working, Marge enjoys boating, horseback riding, traveling, and hiking with her husband and her dog, Rangeley. To learn more about Marjorie, connect with her on LinkedIn.