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What Happens if You Inherit an IRA from someone other than your Spouse?

February 25, 2019

Special rules apply when you inherit an individual retirement account (IRA) from someone other than your spouse. A lot depends on the age at which the IRA owner passed away. Read on.

Surviving spouses have several tax-advantaged options when they inherit an individual retirement account (IRA) from a deceased spouse. However, different rules apply when someone other than the account owner’s spouse inherits an IRA. For starters, a “nonspouse” can’t make contributions to the IRA or rollover the assets into his or her own IRA.

The availability of other options largely depends on the age at which the IRA owner passed away. Here’s more on the rules for nonspouse IRA inheritances.

Owners under Age 70 ½

If you’re a nonspouse beneficiary and the deceased owner wasn’t yet obligated to take required minimum distributions (RMDs) from the account, you essentially have two options:

  1. Take a lump sum distribution. This option avoids the 10% early withdrawal penalty, but you’ll pay ordinary income taxes on the entire distribution. The distribution also could push you into a higher tax bracket.
  2. Open an inherited IRA. Also known as a beneficiary distribution account, this option requires you to take RMDs over your life expectancy, starting no later than December 31 of the year after the owner’s death. Missed RMDs come with a 50% penalty on the shortfall.

Alternatively, if you open an inherited IRA (option 2), you can also take distributions at your discretion, as long as all assets are distributed by December 31 of the fifth year after the deceased owner’s death. Whether you select the life expectancy or five-year method, you’ll be taxed on each distribution from an inherited IRA, but you’ll pay no early withdrawal penalty. And the undistributed assets enjoy tax-deferred growth.

Owners over Age 70 ½

The rules are slightly different if you inherited an IRA from a nonspouse decedent who was over 70 ½, the age at which you’re required to take RMDs. In this scenario, you can take a lump sum distribution, with the same effects. But, if you opt to open an inherited IRA, the five-year method of taking RMDs isn’t available; you can use only the life expectancy method, with the payments spread over the longer of:

  • Your life expectancy, or
  • The decedent’s remaining life expectancy.

Important: You must take an RMD for the year of the death if the owner hasn’t already.

Multiple Beneficiaries

If more than one person inherits an IRA from a nonspouse decedent, each beneficiary should establish separate inherited IRA accounts by December 31 of the year after the owner dies. If you overlook this critical step, RMDs will be based on the oldest beneficiary’s life expectancy. If that person is older than you, you’ll get stuck with larger RMD requirements than you would otherwise, which reduces the tax benefits.

Roth IRAs

Although owners of Roth IRAs aren’t required to take RMDs, nonspouse beneficiaries of Roth IRAs must take distributions. RMDs from nonspouse inherited Roth IRAs are tax-free on accounts that have been held at least five years. However, missing an RMD will result in a 50% penalty, thereby making a major dent in the tax advantages.

Untangling the Web

The rules for inherited IRAs are complicated and strict. Contact our tax team to help you make the best choices for your circumstances.

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