Because Congress gave IRA owners tax benefits for saving in an IRA while they’re alive, the IRA tax laws require that IRA savings must be distributed after the IRA owner’s demise. If you inherit an IRA from someone other than your spouse, you must follow the timing rules for withdrawing money from the IRA or face a stiff penalty—a 50% tax on the amount that should have been taken and was not.
You can always take an immediate payout of all of your inherited assets, but unless you inherited a Roth IRA, you will have to pay tax on the entire amount that you withdraw. You may want to extend your payments over multiple years to stretch out the tax liability. Taking only the required amount also allows you to continue growing tax-deferred investment earnings as long as possible (especially if you inherited a self-directed IRA with alternative investments with limited liquidity).
Beneficiary Payment Options – Although the IRA rules require that you take a minimum amount from the inherited IRA at certain intervals, you have some options for scheduling your payments. The deadline for selecting a payout option is generally December 31 of the year following the year of death. However, the IRS has been known to provide some leeway for estates that are being challenged as well as situations in which the IRA owner did not clearly select specific beneficiaries or selected minors.
Rules for Traditional, SEP & SIMPLE IRAs
Year-of-death RMD – If the IRA owner lived past April 1 of the year after they turned age 70½, they would have already started taking their annual required minimum distributions (RMDs). If the RMD for the year of death hadn’t been paid out yet, you, as the IRA beneficiary, must take the payment. This must be done by December 31 of the year of death.
Life expectancy payments – You may take annual payments from the inherited IRA for the rest of your life as long as you take at least the minimum amount each year. A non-spouse beneficiary must take their first life expectancy payment by December 31 of the year after the IRA owner died. A spouse beneficiary may wait to begin life expectancy payments until the IRA owner would have been age 70½, if applicable.
Each year’s minimum payment is determined by dividing the prior year’s December 31 balance by a factor obtained from an IRS life expectancy table (which can be found in IRS Publication 590-B on the IRS website). If there are multiple beneficiaries of the inherited IRA, you must communicate with the IRA custodian about your share by December 31 of the year after the IRA owner died to retain the greatest flexibility in payment calculations.
Five-year rule – If the IRA owner died before April 1 of the year after reaching age 70½, you may take payments under the five-year rule. This means that you can withdraw any amount from the IRA during the five-year period so long as you deplete the entire IRA by the end of the year that accounts for the fifth anniversary of the IRA owner’s death. Distributions may occur at any time during the five years including a single lump sum payment on December 31 of the fifth year.
Rollover – Some IRA beneficiaries want to move their inherited IRA assets to another IRA custodian to obtain additional investment options or other services. If you were not married to the IRA owner, you may only move your inherited IRA to a new custodian by making a direct transfer of the assets into another inherited IRA. You must continue to satisfy the beneficiary payment requirements from the new inherited IRA.
If you are a spouse beneficiary, you have more options. You may roll over your inherited IRA assets into a different inherited IRA or into your own IRA. If you roll inherited savings into your own IRA, the assets become part of your own IRA and you will not be required to take payments under the inherited IRA rules. You will not have required payments until you reach age 70½ and become subject to the RMD rules. Your IRA custodian may allow you to move inherited assets to your own IRA by simply re-titling the inherited IRA as your own IRA.
Rules for Roth IRAs – The rules for inherited Roth IRAs are generally the same as for inherited Traditional IRAs, with a few differences. Because Roth IRAs are not subject to the age 70½ RMD rules while the IRA owner is alive, the beneficiary payout options are not tied to whether the IRA owner had passed their 70½ birthday before death. The rules are as follows:
- There is no year-of-death RMD for an inherited Roth IRA.
- If the IRA owner had a Roth IRA for at least five years, or five years have passed since this Roth IRA has been opened, the beneficiary’s payouts from the inherited Roth IRA will be tax-free.
- The five-year rule is always a beneficiary payout option regardless of the Roth IRA owner’s age at death.
- If a spouse beneficiary treats the inherited Roth IRA as their own, they will not be required to take distributions when they reach 70½. Roth IRA distributions are not required until after the death of the IRA owner.
Be sure to talk with your financial or tax advisor before selecting a payment method to ensure you understand all of your options and the tax consequences. When you have questions about an inherited IRA or beneficiary options, you can contact my office at 866-694-401k or firstname.lastname@example.org.