Key Takeaways

Spouses have more choices with an inherited Individual Retirement Account (IRA) 

Most nonspouse beneficiaries must deplete an inherited IRA within 10 years 

A knowledgeable professional can help you navigate an inherited IRA

Tax laws surrounding inheritances are always changing, and it’s impossible to say for certain when the next change will come. If you have an inherited Individual Retirement Account (IRA), it’s important to understand the implications—including when it might be time to bring in a financial advisor or tax professional to help you navigate these tricky waters. Some options that beneficiaries choose will mean that withdrawals must be made each year from the inherited IRA, or a 50% penalty is assessed, so please don’t delay getting the help you need.  

Spouses Have More Choices

First of all, there’s a difference when you inherit an IRA from a spouse. You can choose to treat the inherited IRA as your own or roll the money over into your own account. When completing a rollover, it’s important to make sure the tax treatment of the inherited IRA is the same as your existing IRA. If you inherit a Roth IRA, make sure to roll it to a Roth IRA to continue growing any earnings tax-free. Whereas, if you inherit a Traditional IRA (SEP and SIMPLE IRAs count as Traditional IRAs), roll it to a Traditional IRA to maintain your tax-deferred status. As a spouse, you can also disclaim the money, allowing it to go to the next beneficiary in line.

Avoid an oops: If you decide to treat an inherited IRA as your own and then make a withdrawal from it, watch out for the possibility of an early withdrawal penalty. Tapping into the funds before age 59 1/2 could lead to a 10% additional penalty. If you do need spending money and are under 59 1/2 when you inherit the IRA, you might want to make a withdrawal before you treat the IRA as your own to avoid the 10% penalty. Double-check with a tax professional before making a move.

Nonspouses Can No Longer “Stretch” an Inherited IRA

In the past, nonspouse individual beneficiaries could use a life expectancy calculation to figure out how much to take from an inherited IRA. This was a way to reduce the tax burden on the beneficiary. However, since the passage of the SECURE Act, things have changed.

Now, most nonspouse beneficiaries are required to draw down the inherited IRA within 10 years. As a result, some beneficiaries find themselves taking larger chunks out of inherited IRAs—and paying higher taxes. 

Special note for certain beneficiaries of IRA owners who passed away in 2020 or later: While the IRS has yet to publish final regulations, currently proposed regulations would require certain beneficiaries to take annual required minimum distributions (RMDs) from an inherited IRA while also being required to deplete the entire inherited IRA within 10 years following the original IRA owner’s year of death. This proposed rule would generally only impact beneficiaries of deceased IRA owners who are not considered “eligible designated beneficiaries” in situations where a Traditional IRA owner passed away on/after their required beginning date (RBD). Please consult with your tax advisor if you have questions about whether you should take a required distribution from your inherited IRA before December 31, 2022.

As you can tell, if you are a nonspouse beneficiary who is not an eligible designated beneficiary (defined below), knowing whether the person you inherited the IRA from had reached their RBD will be important under the proposed IRS regulations. But what is a RBD? A required beginning date, or RBD, is when the original IRA owner had to start their own RMDs. A RBD has two possibilities:

For those born before July 1, 1949, the RBD is April 1 of the year following the year the IRA owner turned 70 1/2.For those born on or after July 1, 1949, the RBD is April 1 of the year following the year the IRA owner turned 72. 

Bottom line: If the IRA owner died in 2020 or later and if the original IRA owner had not yet reached their RBD and the beneficiary is not an eligible designated beneficiary, then the 10-year rule applies with no RMDs required during the 10-year period. But in this same situation, if the original IRA owner had reached their RBD, then under the proposed rules (which may or may not be enacted as “Final Regulations”), the beneficiary would need to make annual RMDs from the inherited IRA as well as deplete it entirely by the end of the 10-year period. Again, please make sure to consult your tax advisor to determine if you need to take a RMD from your inherited IRA before December 31, 2022, and annually thereafter.

Eligible designated beneficiary:

Surviving spouse
Someone chronically ill or disabledThose only 10 years younger (or less) than the original IRA ownerMinor child, only until age 21

Exceptions to 10-year and proposed inherited IRA rules: Some nonspouse beneficiaries (aka, eligible designated beneficiaries) can still use the life expectancy method. These exceptions include those who are chronically ill or disabled, as well as those who are only 10 years younger (or less) than the deceased IRA owner. Another eligible designated beneficiary is a minor child of the original account owner. However, once the child reaches age 21, the clock starts ticking, and they must deplete the inherited IRA within 10 years (under the 10-year rule).

Pay Attention to Details

Realize that no matter what’s in the will, an inherited IRA goes to the beneficiary listed on the paperwork (or if a beneficiary is not named, the IRA agreements usually specify who will inherit the IRA). On top of that, it’s important to understand whether the deceased IRA owner had already taken a RMD. More specifically, you need to know if the original account owner had reached their RBD. Generally, if the owner had reached their RBD, then the beneficiary who inherited the IRA will have to make annual minimum withdrawals. But if the account owner had not yet reached their RBD, then the beneficiary may not have to make any withdrawals until the end of the year or 10 years after the original account owner died (under the 10-year rule). But as discussed above, pending IRS guidance may provide more direction of when and how much should be withdrawn each year for those who are not eligible designated beneficiaries. Consult a tax advisor to determine if you must make a withdrawal before the end of 2022.

What is the RBD for beneficiaries? It depends.	What is the RBD for IRA owners?
Is the beneficiary an “eligible designated beneficiary”?	For those born before July 1, 1949, the RBD is April 1 of the year following the year the IRA owner turned 70 1/2.
Did the original IRA owner reach their RBD?	The SECURE Act changed the RBD for IRA owners to April 1 of the year following the year the IRA owner turns 72 but only for IRA owners born on or after July 1, 1949.
Did the beneficiary start receiving periodic payments timely?
If there are multiple primary beneficiaries, was the account split up between/among them timely?

Don’t forget to double-check tax laws for changes to estate taxes and inheritance taxes. You might be eligible to receive a tax deduction based on estate taxes paid on the account. For example, if an estate tax was levied at the time of the IRA owner’s death, you might be able to take a tax deduction when you make a withdrawal from the inherited IRA, potentially reducing your tax liability.

Avoid an oops: A tax professional can help you figure out what taxes are owed and what tax breaks you might be entitled to. Consider looking for a professional who specializes in these issues to help you figure out how to manage the details.

Integrate an Inherited IRA into Your Retirement Plan

Receiving an inherited IRA can change the equation on your own retirement planning. You might feel the need to adjust your plans based on an inheritance and other factors. To get started, if you do have inherited IRA assets, use our TD Ameritrade Inherited IRA calculator to help you determine your RMD amount and withdrawal options.

When you receive an inherited IRA, it can change how you withdraw from your tax-advantaged retirement accounts, as well as impact your tax situation. You might adjust when you decide to take Social Security benefits or how you approach your retirement investment portfolio.

A good retirement planning calculator or developing a retirement income plan can help you get a handle on the situation, especially if you follow up by consulting a retirement specialist who might be able to help you create a retirement road map that includes all the factors.

Bottom Line

An inherited IRA can make a big difference in your life. But you need to be aware of some of the sticky situations that can arise. If the paperwork isn’t in order, things can get messy. Plus, it’s a good idea to be aware of how changing tax laws might impact how you manage an inherited IRA. While it may be tempting to use inherited IRA assets as “fun money,” this inheritance may help provide you with the means to secure your own retirement and/or peace of mind. Do it for your future self, so you aren’t a burden to your children or family members.

Are you trying to figure out how to pass on your own IRA? Consider estate planning, including creating a will or trust. Review all your IRA and employer plan (like 401(k)s, 403(b)s, and pension plans) beneficiary forms regularly to help make the inheritance process as easy as possible for those you leave behind. Planning is the true gift of inheritance.

TD Ameritrade does not provide legal or tax advice. Please consult your legal or tax advisor before contributing to your IRA.