Preparing for the unexpected can be one of the best actions you can take to protect yourself, even in the event of a loved one’s death. During an already difficult time, many families have experienced the added challenge of not knowing how to properly manage the deceased’s assets. What steps need to be taken if you’re the beneficiary?
If you’re the heir to an Individual Retirement Account (IRA), seek advice from a financial professional who can help you navigate the most current rules and regulations in place. Having knowledge about these requirements helps to ensure you receive the full benefits of your inheritance and avoid significant penalties later.
Understanding Inherited IRA Rules
Also known as a beneficiary IRA, an inherited IRA is an account opened for a person who is bequeathed an IRA or employer-sponsored retirement plan. After the original owner passes away, these assets typically need to be moved to this new account in the beneficiary’s name. Depending on the type of IRA being inherited, several guidelines should be kept in mind to help ensure the transition process and overall maintenance both go smoothly. How your inheritance is handled depends on a few factors:
- Your relationship to the deceased
- When the original owner passed away
- Age of the original owner at the time of his/her passing
Learn the Details of Your Inheritance
Did you inherit a traditional IRA or a Roth IRA? Each of these accounts is governed by a specific set of rules. While inherited IRAs are largely treated the same no matter the type, the withdrawal rules vary. Each type of account has certain benefits and limitations:
The owner of a traditional IRA is required to take minimum withdrawals when they turn 72 years old. If the deceased was older than 72 when they passed, the first thing to do is ensure the required minimum distribution has been met for the year. If this step isn’t taken, you could face a significant penalty imposed by the IRS.
The owner of a Roth IRA typically enjoys tax-free withdrawals depending on when the original account was opened. If you’ve inherited a Roth IRA, distributions are free of taxes if the account is at least five years old. If the account was held for less than five years, you may owe taxes on distributed earnings.
Beyond the specifics of the type of account bequeathed, additional rules may apply. The next steps taken are guided by specific factors, depending on whether the assets are going to a spouse or another person/entity.
Inherited IRA Rules for Spouses
When it comes to inheritance IRAs, spouses have the most flexibility. According to the IRS, there are a few ways for a spousal heir to handle these assets. Two common paths include:
- Making a spousal transfer: In this scenario, spousal heirs transfer assets from the original owner’s account into their own traditional IRA. They can also be rolled into any of the following accounts:
- Qualified employer plan
- Qualified employee annuity plan
- Tax-sheltered annuity plan
- State/local government deferred compensation plan
- Treating this account as your own: If you wish to take this route, you’ll need to designate yourself as the owner of the IRA account.
Inherited IRA Rules for Non-Spouses
While options are more limited, heirs other than spouses can also inherit IRAs. If you’re the friend, child, or sibling of the deceased, it’s crucial to understand the guidelines in place based on your connection. Most recently, the rules for non-spousal beneficiaries have changed due to the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019.
Your options vary based on when the original owner passed. If the death occurred before December 31, 2019, the following rules apply:
- The original owner died before reaching age 70-1/2: You can collect RMDs no later than December 31 of the year after his or her death. You may also take advantage of the five-year rule. Under this rule, you may receive distributions without penalty until all the assets are fully distributed from the inherited IRA by the fifth year following the previous owner’s death.
- The original owner died after age 70-1/2: Beneficiaries may calculate RMDs using their own age or the original owner’s age. Typically, this option is useful if you’re older than the original IRA owner.
If the death occurred on or after January 1, 2020, this is where the new rules in the SECURE Act come into play. In this scenario, beneficiaries must distribute the funds from an inherited IRA within 10 years of the original owner’s passing. However, not every heir is required to follow the 10-year rule. If the beneficiary meets the criteria listed below, they may choose to withdraw funds throughout their lifetime:
- Chronically ill
- A minor
- Someone more than a decade younger than the deceased
Seek Advice from a Financial Professional
When you’ve received an inherited IRA, consult a financial professional. At Park Place Financial, we can help you navigate the complexities of your inheritance. Reach out to our team in Bellaire, Texas, for more information today.