Inherited IRA Distribution Rules
Published on October 09, 2024
by Darryl Albuquerque
Darryl Albuquerque, an IRS Enrolled Agent with 19 years of expat tax experience, specializes in US tax preparation, tax planning and tax advice for US citizens and Green Card holders living and working in the Middle East. Darryl also specializes in helping clients through the Streamlined Tax Amnesty Program.
Table of Contents
What happens when you inherit an IRA?
You are able to receive the benefits of the individual retirement account (IRA) after the owner passes away.
An IRA is a personal savings plan designed to help individuals save for retirement with tax advantages.
Who has the right to inherit an IRA?
A beneficiary can be any person or entity the owner chooses to receive the IRA’s benefits once they are deceased.
Who are the beneficiaries?
- Spouse
- Non-spouse individuals: named beneficiary other than the spouse.
- Trusts: If a trust is named as the beneficiary of an IRA, the individuals from the trust will be treated as the designated beneficiaries.
- No designated beneficiary: Charities, estates, or non-designated trusts. These cannot be a designated beneficiary, even if it is a named beneficiary.
How can beneficiaries benefit from an inherited IRA?
Beneficiaries can benefit from the IRA by claiming “distribution” or the withdrawal of funds from the IRA account.
Beneficiaries must also include in their gross income any taxable distributions they receive for the year as the distributions are usually divided based on their life expectancy.
Required Minimum Distributions (RMDs)
Required Minimum Distributions (RMDs) are the minimum amounts that IRA owners must withdraw annually starting at age 72 (or 73 for those who turn 72 after December 31, 2022).
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How are your distributions handled as a spousal beneficiary?
You generally have three choices in handling distributions:
- Continue as a beneficiary
- Roll over to your existing IRA or another taxable plan such as:
- Qualified employer plan
- Qualified employee annuity plan
- Tax-sheltered annuity plan
Deferred compensation plan of a state or local government
- Treat it as your own IRA: You can continue the IRA account as if it were your own.
- You can contribute to the inherited IRA (including rollover contributions).
- You have the unlimited right to withdraw amounts as needed.
However, some of these options are subject to Required Minimum Distributions (RMDs).
Required Minimum Distributions (RMDs) for Spousal Beneficiaries
- If you continue as a beneficiary:
- If the IRA owner was already taking RMDs, the beneficiary must begin to receive them by December 31 of the year after the owner’s death.
- If the RMDs had not been claimed yet, the beneficiary could delay distributions until the year the deceased owner would have turned 72.
- If you treat it as your own IRA:
- RMDs are based on your age, and the same rules apply to an IRA owner.
How are your distributions handled as a non-spousal beneficiary?
You are not required to claim the Required Minimum Distributions (RMDs) from the inherited IRA.
Still, all the funds on the account should be withdrawn within ten (10) years of the original owner’s death or the “10-year rule”.
However, some situations are exempt from the 10-year rule, which are the Eligible Designated Beneficiaries:
- Disabled individuals
- Chronically ill individuals
- Minor children of the original owner (until they reach the age of majority)
- Beneficiaries not more than ten (10) years younger than the original owner
How are distributions handled for trusts?
The required minimum distributions (RMDs) after the owner’s death will be based on the life expectancy or status of the trust beneficiaries rather than the trust itself.
Are distributions taxable?
Yes, distributions from an inherited IRA are typically taxed as regular income.
Funds in a traditional IRA account are tax-deferred upon contribution. When distributions are received, they will be added to the beneficiary’s taxable income for the year with the year’s tax rate.
What is the difference between a traditional IRA and a Roth IRA?
The key difference between these two individual retirement accounts is when you will pay the taxes on contributions and earnings.
For traditional IRAs, your contributions can be made with pre-tax dollars, and the money can be subject to tax deduction upon receipt of the distribution.
For Roth IRAs, your contributions are made with after-tax dollars, and upon maturity, distributions will not be included in your taxable income for the year, but they will not qualify for tax deductions.
Is it possible for a beneficiary to decline an inherited IRA?
Yes, it is a process called disclaiming the inheritance.
The refusal must be in writing and within nine months of the original owner’s death; most who do this wants to avoid any of the gift and income tax consequences associated with receiving the property.
What happens when there are multiple beneficiaries?
Multiple individual beneficiaries can choose to retain a combined account or divide it into their own.
- Combined account: The distribution rules will be based on the beneficiary with the shortest life expectancy.
- Separate accounts: The IRA can be divided into separate accounts for each beneficiary by December 31 of the year following the original owner’s death. Each individual can choose their distribution method and can take distributions based on their own life expectancy or under the 10-year rule.
What if the beneficiary of the IRA is a minor?
A beneficiary who’s a minor is still an eligible designated beneficiary.
Minor beneficiaries fall under special rules for receiving distributions:
- Required Minimum Distributions (RMDs): Minor beneficiaries can begin to claim RMDs upon the original owner’s death until they reach the age of majority, usually 18 or 21, depending on state law.
- 10-Year Rule: Once they reach the age of majority, the 10-year rule requires that the entire balance of the IRA be withdrawn within ten years.
These special rules ensure that the inherited IRA is managed appropriately until the minor reaches the age of majority.