IRA is an investment vehicle provided by financial institutions to help individuals and couples save for retirement.
An Inherited IRA, as the name suggests, is an IRA that you inherit as a beneficiary.
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IRAs can be kept at a bank with a savings rate, or be exposed to the stock market, depending on your risk tolerance and retirement goals. But an IRA, in all cases, are to help lessen taxes on income now, or later when you are in retirement.
You may end up with an Inherited IRA without being ready for what it entails. So read on to learn more about how an Inherited IRA works and what you can do with it.
And if you are setting up a new IRA, see what steps your beneficiaries can take and what it means to inherit an IRA.
When the owner of an IRA passes away, the existing IRA in the owner’s name gets passed to the listed beneficiaries as an Inherited IRA.
This can be an employer sponsored retirement plan or any type of an Individual Retirement Account.
ℹ️ Owner: The person who opened the original IRA account and who’s name it is inℹ️ Beneficiary: The person inheriting the IRA account at the event of the owner’s passing
At the time of opening, the owner of the IRA has to list the beneficiaries of their IRA account in case of their passing. The beneficiaries can be altered through the life of the IRA by the owner.
At the passing of the owner, the IRA will then be transferred to the beneficiary as an Inherited IRA. The beneficiary can be a person or an entity, like a trust or estate too.
But Inherited IRAs behave differently depending on if you are a spouse of the owner or a non-spouse. See below on how it works.
|🎯 Quick Take: Inherited IRA|
Spouses often list each other as the beneficiary of an IRA, so that the proceeds go to the spouse at their unforeseen passing.
The IRA states that there are 3 different options for next steps if you inherit a traditional IRA from your spouse:
- You can become the account owner where the IRA becomes your own
- You can roll it into your existing IRA, or depending on your circumstances, a qualified employer plan or annuity plan.
- Be the beneficiary of the IRA
The options are wider for spouses as the beneficiary of an IRA. Unlike non-spouses, a spouse can have an Inherited IRA become their own.
|ℹ️ Spouses can take ownership of an Inherited IRA as their own and make contributions towards it|
An Inherited IRA from a spouse becomes your own if you start making contributions to the account or if you don’t take the Required Minimum Distributions for a year.
But the option to be an Inherited IRA account owner is only available if you are the sole beneficiary of the IRA and you have an unrestricted right to withdraw from it. So if you are not the sole beneficiary of the account, as listed by the original owner, you will not be able to make an Inherited IRA your own.
Read the section on Inherited IRA distributions to know how Required Minimum Distributions, or RMDs, factor in for Inherited IRAs for a spouse.
If you got an Inherited IRA from a parent, family member or anyone that is non-spouse, there are more restrictions on what you can do with the account.
|ℹ️ A Non-Spouse inheriting an IRA is not able to take ownership of the account or make contributions|
Non-spousal beneficiaries are not able to make the IRA account their own, and instead have to keep it specifically in an Inherited IRA account where it can grow tax-deferred. They can also take a distribution.
As a non-spouse you are not able to roll over any amounts out of the Inherited IRA into your own accounts. Instead, IRAs from a non-spouse for a traditional IRA means that you will have to move the funds into a new Inherited IRA account. And you will not have to pay taxes until you take distributions from the account.
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The first steps you take depend on whether you are a spouse or not. Second, if you are the sole beneficiary, or amongst others, on the owner’s IRA.
Spouses have the option to take on the account as the new owner or roll the account over into their existing IRA accounts. Spouses can take it on as a beneficiary as well.
As a spouse inheriting an IRA, you can also roll it over and convert it into a Roth IRA account too, but you will need to pay taxes on it due at the time of conversion. It is best to consult a tax or retirement planning professional to figure out which option is best for you.
If you are a non-spouse who may be inheriting an IRA, you can keep it in an Inherited IRA account, or you can take income from it. Let’s see what that entails.
Distributions from Inherited IRAs have gone through a few changes since the December 2019 passing of the SECURE Act. And there are specific IRS mandates for reporting distributions from an Inherited IRA.
First, whether you are a spouse or a non-spouse, if you don’t take the RMDs from the Inherited IRA appropriately or as designated by the new setup, there is a penalty of 50% of the amount.
|ℹ️ Any distributions taken from an Inherited IRA, that is not a Roth IRA, will be treated as income and will be subject to income taxes.|
If you are a spouse with an Inherited IRA, and you roll it over, you can defer Required Minimum Distribution requirements from the account until you are 72 years old.
If you don’t take ownership and continue as a beneficiary of the account, and the original owner was already taking distributions as RMDs at the time of their passing, you will continue to receive the RMDs based on your own life expectancy.
Spouses also have the option to take the assets and put it into an Inherited IRA and then withdraw the funds without getting the 10% withdrawal penalty.
What about for non-spouses?
Non-spouses, such as other family members or children, have specific rules. To clarify, non-spouses are not able to own the Inherited IRA from the owner, and instead have to open a separate Inherited IRA account.
|ℹ️ If there are multiple beneficiaries of an Inherited IRA, each beneficiary will need to open an Inherited IRA for their portion of the Inherited IRA proceeds.|
As of 2019, if you are not a spouse or a minor child of the IRA’s owner, then you are required to withdraw all the assets from the account within 10 years. The clock on the 10 years ends on December 31st of the 10 year anniversary of the owner’s passing.
This can be taken as a lump sum distribution if you would like as well. But you will sacrifice tax-deferred growth and will have to pay taxes on the lump sum.
In all cases, there can be individualized nuances to each account and beneficiary set up. It is best to talk to a tax advisor on taking distributions from an Inherited IRA as all income will have tax implications.
You can open an Inherited IRA at most banks and financial institutions, including Fidelity, Vanguard, Charles Schwab and others. Certain places will allow for you to open the account online.
You will need the details of the deceased owner’s IRA and a copy of the death certificate.
Much like a traditional IRA or a Roth IRA, you can invest the assets in an Inherited IRA. You can put the funds in a CD, mutual funds, exchange traded funds, or stocks and bonds.
You can choose the appropriate investment vehicle to grow the funds tax deferred based on your risk profile and retirement plan.
- IRS Gov- Inherited IRA Beneficiaries
- Advantages of an Inherited IRA
- RMD Rules for an Inherited IRA
- RMD Rules for an Inherited IRA- Vanguard
- Inherited IRAs- Fidelity
- Contributions to Individual Retirement Accounts
This publication is provided for general information purposes only and is not intended to cover every aspect of the topics with which it deals. It is not intended to amount to advice on which you should rely. You must obtain professional or specialist advice before taking, or refraining from, any action on the basis of the content in this publication. The information in this publication does not constitute legal, tax or other professional advice from TransferWise Limited or its affiliates. Prior results do not guarantee a similar outcome. We make no representations, warranties or guarantees, whether express or implied, that the content in the publication is accurate, complete or up to date.
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