What Happens When You Inherit an IRA?

The SECURE Act and IRAs

The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 made several alterations to rules around IRAs, including imposing the 10-year rule governing distribution of funds in IRAs inherited from individuals who died on or after January 1, 2020. (Different rules applied to IRAs owned by those who died before 2020, and this article does not address them.)

The applicability and implementation of the 10-year rule depends chiefly on two things: the nature of your relationship to the original account owner who left you the IRA, and whether the IRA is a traditional IRA or a Roth IRA. The rules that apply in each case are covered below.

How the 10-Year Rule Works

The 10-year rule requires the account inheritor, or beneficiary, to deplete all the funds in the account by the end of the 10th year following the original owner's death. This generally applies to IRA beneficiaries who are not the spouse of the original account owner.

Depleting the account can be accomplished through withdrawals in any amount, taken at any interval, as long as the account balance is zero by the end of the 10-year period. Funds withdrawn from traditional IRAs received as inheritance, or from inherited Roth IRAs that are less than five years old at the time of the original owner's death, are taxable as income.

If you fail to deplete an IRA that's subject to the 10-year rule, any funds remaining at the end of the mandatory distribution period are subject to a 50% tax penalty.

Who Is Exempt from the 10-year Rule?

Persons exempt from the 10-year rule include:

• Minor children of the original account holder
• Beneficiaries with chronic illnesses or permanent disabilities
• Any beneficiary who is not more than 10 years younger than the original account holder
• The spouse of the original IRA owner, if named as the account's sole beneficiary, at their discretion (more on that below)

If you are exempt from the 10-year rule, you may assume ownership of an IRA you inherit, and make contributions and withdrawals as though you'd opened the account yourself, in accordance with rules that apply to the type of IRA (traditional or Roth). The birthdate of the beneficiary who assumes ownership, not that of the original owner, applies to the ban on funds being withdrawn without penalty before age 59½ and, in the case of a traditional IRA, when distributions must begin at age 72.

If you assume ownership of an IRA you inherit, you can designate one or more beneficiaries to the account.

Spousal vs. Non-spousal Inheritance

IRAs Inherited From a Non-spouse

You are subject to the 10-year rule if your parent, grandparent or someone else who isn't your spouse leaves you an IRA unless you fall under one of the exemptions listed above. You must establish a designated inherited IRA account, which cannot receive any new contributions and must be depleted by December 31 of the 10th year after it is opened. This is true whether you are the sole named beneficiary on the account, one of several named beneficiaries or a recipient of a share in an IRA through an estate trust.

Funds can be distributed at any interval and in any amount within that 10-year period. No matter your age, distributions are exempt from the 10% early withdrawal tax penalty, but if the account is a traditional IRA or a Roth IRA that was less than five years old when the original owner died, distributions are treated as taxable income. (Roth IRAs are funded with after-tax income, so aside from the exception for funds less than five years old, distributions from them are not taxable.)

IRAs Inherited From a Spouse

If you inherit an IRA from your spouse as the sole named beneficiary on the account, you have the following options, in addition to assuming ownership of the account as described above:

• Roll the contents into an existing IRA. If you already have an IRA, you can move the funds you inherited into your own. If you do so, the added funds become subject to the same tax rules and penalties as your other contributions to the fund, including a 10% income-tax penalty on withdrawal made before age 59½. This is a good option if you don't need access to any cash right away, and you want to bolster your retirement savings.
• Open an inherited IRA with a 10-year distribution. This is essentially opting in to the 10-year rule: You establish a designated "inherited IRA" account, which cannot receive new contributions and which must be fully liquidated in accordance with the 10-year-rule procedures described above. This can be a good option if your retirement savings are in good shape and you want to make use of the funds over the next 10 years.
• Open an inherited IRA with distributions spread out over your expected lifetime. With this option, you open a designated inherited IRA that cannot receive new contributions, and from which you must withdraw funds at annual intervals in amounts known as required minimum distributions (RMDs), calculated using life-expectancy tables compiled by the IRS. If the original account owner died before the age of 72, RMDs must begin on December 31 in the year of the original owner's 72nd birthday. If the original account owner was 72 or older when they died, RMDs must start by December 31 of the year following the original owner's death. Distributions can be taken in any amount as long as annual RMD requirements are met, so you'll have access to the funds anytime you need them, exempt from the early-withdrawal tax penalty even if you are under the age of 59½. Funds withdrawn from traditional IRAs and Roth IRAs less than five years old are taxed as income, however, so plan accordingly.
• Take a lump-sum distribution. Under this option, you cash out the full contents of the inherited IRA all at once. No early-withdrawal tax penalty applies, but the funds are taxed as income. This may be a good option if you really need the full cash amount right away (and have taken the increased tax exposure into account). For most individuals, one of the inherited IRA options described above gives you the option of withdrawing all cash at any time, without compelling you to do so.

Note that the rules above apply to both traditional IRAs and Roth IRAs inherited from a spouse. A Roth IRA you establish yourself is exempt from RMD requirements during your lifetime, but Roth IRAs received as inheritance must be distributed using either the 10-year rule or the life-expectancy method described above.

Also note that if you inherit a traditional IRA from an individual over the age of 72, who was therefore required to take an annual RMD from the account, an RMD must be withdrawn for the year that the individual died if they had not taken it themselves before their death.

The Bottom Line

The 2019 SECURE Act significantly complicated the obligations and tax implications of inheriting an IRA, and the new rules it imposes could cost you a lot in penalties or in taxes. If you inherit an IRA, it's probably wise to consult with a financial professional or attorney familiar with estate law to help decide on strategies that can best protect the gift your loved one worked to set up for you.