The "best" thing to do with an inherited IRA isn't a one-size-fits-all answer; it largely depends on your relationship to the deceased, your age, your financial needs, and your tax situation. Understanding the various distribution options and their tax implications is crucial for making an informed decision.
Key Considerations for Inherited IRAs
When you inherit an IRA, your primary objective should be to maximize its value while minimizing tax liabilities. The rules vary significantly based on whether you are a spouse or a non-spouse beneficiary.
Options for Spousal Beneficiaries
If you are the spouse of the deceased IRA owner, you generally have the most flexibility, offering several advantageous options:
- Roll Over to Your Own IRA: This is often the most common and advantageous option. You can treat the inherited IRA as if it were your own, rolling the assets into an existing IRA or a new one established in your name. This allows you to continue tax-deferred growth (or tax-free growth for Roth IRAs) and delay distributions until you reach your own Required Minimum Distribution (RMD) age (currently 73).
- Treat as Your Own IRA: You can simply retitle the inherited IRA into your name as the owner. The RMD rules will then apply as if it were your own retirement account.
- Take Distributions as a Beneficiary: You can choose to keep the account as an inherited IRA and take distributions as a beneficiary. This might be beneficial if you are under age 59½ and need the funds without incurring the 10% early withdrawal penalty that would typically apply to your own IRA.
Options for Non-Spousal Beneficiaries
For non-spousal beneficiaries, the rules are generally more restrictive, with the 10-year rule being the most significant change under current regulations.
The 10-Year Rule
For most non-spousal beneficiaries, the Setting Every Community Up for Retirement Enhancement (SECURE) Act introduced the 10-year rule.
- Mandatory Distribution Period: Under this rule, all assets in the inherited retirement account must be fully withdrawn before the end of the tenth year following the original owner's death. This means you have a decade to empty the account, but there are no mandatory annual distributions within that 10-year period. You could take it all out in year one, spread it out over 10 years, or wait until year 10 to take a lump sum.
- Penalties for Non-Compliance: Failure to distribute the entire balance by the 10-year deadline can result in significant penalties on the undistributed amount.
- Minor Children Exception: For a minor child who inherits an IRA, the 10-year rule typically kicks in once they reach age 21. This provides a longer window for tax-deferred growth during their minority.
Other Non-Spousal Considerations:
- Lump-Sum Distribution: While an option, taking a full lump-sum distribution can result in a significant tax bill, as the entire amount (for traditional IRAs) becomes taxable income in the year of withdrawal. This is generally not recommended unless immediate funds are critically needed.
- "Eligible Designated Beneficiaries": Certain non-spousal beneficiaries, categorized as "eligible designated beneficiaries," may still be able to stretch distributions over their own life expectancy, similar to pre-SECURE Act rules. This group includes:
- The deceased's surviving spouse (as noted above).
- A chronically ill or disabled individual.
- An individual who is not more than 10 years younger than the deceased IRA owner.
- Minor children (until they reach age 21, then the 10-year rule applies).
Factors Influencing Your Decision
To determine the "best" approach for your situation, consider these factors:
| Factor | Impact on Decision |
|---|---|
| Your Tax Bracket | Taking large distributions in a single year could push you into a higher tax bracket. Spreading withdrawals over the 10-year period can help manage this. |
| Your Age & Needs | Do you need the money now? If you're young and don't need the funds, continuing tax-deferred growth for as long as possible is generally preferable. |
| Type of IRA | Traditional IRA: Distributions are taxed as ordinary income. Roth IRA: Qualified distributions are generally tax-free. This makes Roth inherited IRAs simpler to manage from a tax perspective during withdrawal. |
| Other Investments | How does this inherited IRA fit into your overall financial plan? Do you have other retirement savings? |
| Estate Planning | If you don't need the funds, consider leaving some of the balance for future generations, understanding the 10-year rule for their inheritance. |
Practical Insights
- Seek Professional Advice: Given the complexities and potential tax implications, consulting with a financial advisor or tax professional is highly recommended to create a personalized strategy.
- Strategic Withdrawals: If subject to the 10-year rule, consider taking smaller distributions over the decade rather than a single lump sum, especially if the account is large. This can help manage your annual tax liability.
- Required Minimum Distributions (RMDs): While the 10-year rule for non-spouses does not require annual distributions, if the original IRA owner was already taking RMDs, you might need to take the deceased's RMD for the year of their death if it hadn't been taken yet.
By understanding these options and considerations, you can make an informed decision that aligns with your financial goals and minimizes tax burdens on your inherited IRA.
