There’s a lot to consider when you've lost a loved one, especially if they leave behind an inheritance. If you’re inheriting an IRA or a workplace savings account, like a 401(k), there are some rules and timeframes you’ll need to consider.
If you plan to disclaim all or part of your inheritance in an IRA, you’ll have to do that within 9 months of the death of your loved one and before you take possession of the money. The timeframe for disclaiming a workplace plan could also be shorter, depending on the plan rules.
Understanding required minimum distribution (RMD) rules
Workplace plans and traditional IRAs usually have an RMD that the account owner must take each year before year end, if you’re 73 or older. Timing may be different for inheritors, but you could owe a 25% penalty to the IRS if the RMD is not taken.1
If you inherit an IRA, your RMD rules aren’t based on your required beginning date. Some factors you’ll need to know to determine your distribution rules are:
- Your age
- The original account owner’s date of birth
- If you inherited the account timely or untimely
- Your relationship with the account owner
- Whether the account owner was in pay or not in pay
All these factors can affect how long you’ll have to empty your account and your annual distribution amount.
Like withdrawals from a traditional IRA, RMD withdrawals from inherited IRAs are taxed as income. Inherited Roth IRA distributions are generally tax-free if the assets have been in the owner’s account for 5 years or more.2
Taking care of your loved one’s final RMD in an inherited IRA
If your loved one reached RMD age before they passed away, you’ll need to make sure their final RMD was taken before you take a distribution for yourself. If it wasn’t, you’ll have until December 31 of the year they passed away to take it. If there’s more than one beneficiary on the account, you should work together to ensure you take the full amount.
If your loved one’s IRA was at Fidelity, you'll need to open a beneficiary distribution account (BDA) to take the withdrawal. If their account was not at Fidelity, find a statement and contact the financial institution to determine your next steps.
Inheriting an IRA from someone who isn’t your spouse (for example, a parent)
If you’ve been named as a beneficiary on a retirement account from someone other than your spouse, your rules will depend mostly on when you inherited the account. SECURE Act 2.0 created new rules that apply to most non-spouse beneficiaries who inherit from original depositors who passed away in 2020 or later.
Non-spouse beneficiaries who inherited from someone who passed away in 2019 or earlier, can continue following withdrawal schedules in place before the enactment of the SECURE Act in 2019 and the 2022 IRS regulations.
Special rules for eligible designated beneficiaries of inherited IRAs
SECURE Act 2.0 allows for exceptions to the shorter distribution time limit, if you’re an eligible designated beneficiary (EDB). You can be an EDB if one of these is true for you:
- You’re the surviving spouse of the original account owner.
- You’re not more than 10 years younger than the original account owner.
- You’re chronically ill or disabled according to the IRS definition.
- You’re a minor child (haven't reached the age of majority in your state) of the original account owner.
Inheriting an IRA from your spouse
As a spouse, you’ll have the choice of moving the inherited balance into an inherited account or combining it with your own accounts. Deciding what’s best for you will depend on your age, expected retirement date, tax considerations, immediate need for cash, and any need for creditor protection.
It’s easy to get overwhelmed with all the choices, especially during such a difficult time, but it’s important not to rush to a decision that might not benefit you in the end. If you are the spouse of an IRA owner, you generally have 4 options with respect to the disposition of inherited IRA assets:
1. Roll over the assets into a new or existing IRA in your own name
2. Transfer the assets to an inherited IRA
3. Roll over the IRA assets into a new or existing IRA and then convert the assets to a Roth IRA
4. Disclaim (decline to inherit) all or part of the assets
If you’re younger than 59½ there may be penalties. Consider working with a qualified tax professional to help make sure you’re taking full advantage of your inherited assets.
Inheriting an IRA from an entity (for example, a trust or estate)
Trusts and estates have special rules that can complicate inheriting an IRA. The trust or estate will need directions from the executor or trustee to make sure your loved one’s final wishes are followed, and you’ll have to follow the rules established by the trust or estate for your distributions.
If you inherit from a trust, you’ll want to ask the trustee in charge or work with your trust attorney to understand what kind of trust you’re inheriting from. Once you know the rules of a trust, you’ll want to work with a tax professional to decide how to take your distributions.
Inheriting an inherited account
If you inherit an account that was already inherited, your options depend on the original account owner and their original beneficiary, who you inherited from. You’ll need to know when both account owners passed away and possibly what distribution rules your loved one was using for their inherited IRA. In this situation, it’s a good idea to consult an attorney or tax professional.
Inheriting a Roth IRA or workplace retirement plan
You’ll need to keep traditional and Roth IRA accounts separated, since they’ll have different tax treatments and distribution rules.
If your loved one met their 5-year aging requirement for their Roth IRA, meaning it had been at least 5 years since they made their first contribution, then you’ll be able to take tax-free withdrawals from the account. Depending on when you inherited the account, you might have an RMD or a limited amount of time to empty the account, but you usually won’t owe taxes on the distributions.
For workplace retirement plans, you’ll need to work with your loved one’s employer or the recordkeeper who managed their retirement plan to know what kind of contributions they made. This will be important for finding out what kind of inherited IRA the money can be moved into. Some employer plans might let you keep the inheritance in an inherited workplace retirement plan for a set amount of time.
Inherited workplace savings plans also allow beneficiaries the same net unrealized appreciation (NUA) benefits as the original account owner, which might help reduce what you owe in taxes. NUA doesn’t apply to IRAs, so it’s a good idea to work with a tax advisor before moving the workplace plan into an inherited IRA.
What happens with other types of inherited accounts?
Inheriting retirement accounts can be complex, but non-retirement accounts, like individual or cash management accounts, are usually straightforward. In most cases, you can move the inheritance to an account in your name and start making investment decisions or withdrawals.
If you had a joint account with your loved one, with the right paperwork you can often remove or add account owners without changing the account. You won’t have the hassle of moving it into any kind of inherited account, and you’ll most likely be able to cash out once the money has been transferred to you.
These accounts can be easier to access quickly but be aware of tax implications if you’re working with investments in the account. Consider consulting a tax professional to talk through your specific situation.
Glossary of common terms for inherited IRAs
Legal and financial vocabulary can be difficult to understand when it's new. Here's a brief glossary of common terms you may encounter in the process of inheriting an IRA.
- Beneficiary: The person who receives the money when an account holder passes away, who may be a spouse, another person (non-spouse beneficiary), or a trust or entity —which have different options for handling money depending on the type beneficiary.
- Eligible designated beneficiary (EDB): A type of beneficiary that can only apply in situations where the original depositor passed away on or after January 1, 2020—can be the spouse, minor child of the original depositor, a disabled or chronically ill person, or an individual that is not more than 10 years younger than the original depositor.
- Entity: Refers to a beneficiary that's not a person such as an estate, a charity, or a non-look-through or non-see-through trust.
- Traditional IRA (individual retirement arrangement): A type of retirement savings account with tax advantages and where contributions may be tax-deductible.
- Roth IRA: A retirement savings account where contributions are made with after-tax dollars. Future withdrawals are tax-free, as long as the account is at least 5 years old. Contributions can be withdrawn without penalty at any time, for any reason.
- Inherited IRA or Beneficiary IRA: Inheritors of retirement accounts move their inheritance into an inherited IRA to maintain tax status and ensure withdrawal rules are followed.
- RMD (required minimum distribution): A mandatory annual withdrawal from tax-deferred retirement accounts that starts when the account owner reaches the age of 73 (rising to 75 in 2033). Timing may differ for inheritors.
- Required beginning date: The date by which an individual must take their first RMD from their traditional IRA—April 1st of the year after the individual reaches RMD age.
- Inherited timely: The timing of moving inherited assets into your inherited account can play a role in determining your distribution rules. For an inheritance to be timely, it needs to be moved into your name by December 31 of the year after the original account owner passed away.
- Inherited untimely: If the inheritance is not moved into your inherited account by December 31 the year after the original account owner passed away, then it was inherited untimely.
- Rollover: A transfer of assets from one retirement account to another without having to pay taxes.
- Disclaim: You give up your right to receive an inheritance. Whatever assets you were meant to receive are passed on to the next designated beneficiary.