When you inherit an IRA, you must follow IRS rules for withdrawals and taxes based on your relationship to the original owner and account type. Failure to comply can trigger penalties.
The IRS treats inherited IRAs differently depending on whether the account was a traditional IRA or Roth IRA, and whether the beneficiary is a spouse or non-spouse. These rules determine how quickly you must take distributions and how much you'll owe in taxes.
Inherited IRAs fall into two main categories: spousal and non-spouse beneficiaries. Spouses have more flexibility, while non-spouses face stricter rules.
| Beneficiary Type | Distribution Rules | Tax Treatment |
|---|---|---|
| Spousal Beneficiary | Can treat the IRA as their own, name themselves as the account owner, or take distributions based on their life expectancy. | Taxed as ordinary income upon withdrawal if traditional IRA; tax-free if Roth IRA and meets the five-year rule. |
| Non-Spouse Beneficiary | Must take required minimum distributions (RMDs) annually based on their life expectancy or distribute the entire balance within 10 years. | Taxed as ordinary income upon withdrawal if traditional IRA; tax-free if Roth IRA and meets the five-year rule. |
These rules apply to all inherited IRAs, regardless of the account balance. The primary goal is to ensure the IRS receives deferred taxes, as traditional IRAs offer tax-deferred growth and Roth IRAs offer tax-free growth after meeting certain conditions.
For example, if you inherit a traditional IRA worth $200,000, you'll need to take distributions and pay taxes on the withdrawals. If you inherit a Roth IRA worth $200,000, you won't owe taxes as long as the account has been open for at least five years.
Many people believe they can keep an inherited IRA indefinitely, but the SECURE Act changed the rules. Non-spouse beneficiaries must now take full distributions within 10 years, regardless of their age.
Another misconception is that inherited Roth IRAs are always tax-free. While contributions to a Roth IRA are made with after-tax dollars, earnings withdrawn within five years of the original owner's death are subject to income tax and a 10% penalty.
Suppose your spouse passes away and leaves you a traditional IRA worth $150,000. As the surviving spouse, you can either treat the IRA as your own or take distributions based on your life expectancy. If you choose to take distributions, you'll pay taxes on the withdrawals as ordinary income.
If a non-spouse, such as a child, inherits the same IRA, they must take required minimum distributions annually based on their life expectancy or distribute the entire balance within 10 years. Any withdrawals will be taxed as ordinary income.
The rules for inherited IRAs depend on your relationship to the original owner and the type of IRA. Spouses have more flexibility, while non-spouses face stricter distribution requirements. Understanding these rules is important to avoiding penalties and managing your tax obligations effectively.