When it comes to retirement planning, many people focus on how to grow their self-directed IRA during their lifetime. But what happens to those assets after you’re gone? Estate planning and inheritance rules can significantly affect how your beneficiaries manage and access your IRA. From the differences between spousal and non-spousal beneficiaries to the impact of the SECURE Act’s 10-year distribution rule, understanding how inherited IRAs work is essential for protecting your legacy and ensuring a smooth transfer of wealth.
An inherited IRA is an account established by a beneficiary to hold the assets and cash from the original account owner’s retirement account after their passing. While anyone can inherit an IRA, the rules vary depending on the beneficiary’s relationship to the deceased. A spouse is the most common type of beneficiary and has the most flexibility. If listed as the sole beneficiary, a spouse can treat the IRA as their own. They may take a full distribution and close the account, or they may establish a separate inherited IRA. How the account is managed will depend on the age of the deceased, since required minimum distribution (RMD) rules differ depending on whether the spouse assumes ownership or opens an inherited IRA. In these cases, RMDs are based on the spouse’s own RMD age or delayed until the deceased would have reached their RMD age.
Non-spousal beneficiaries have more limited options. They cannot treat the IRA as their own and must either open an inherited IRA or take a lump sum distribution to close the account. The SECURE Act of 2019 requires most non-spousal beneficiaries to withdraw all funds within ten years. In addition, entities such as a trust, estate, will, or charity may also be named as beneficiaries. These are considered non-designated beneficiaries and, in most cases, must distribute all assets within five years if the original account owner passed away before reaching their RMD age.
The key rules for inherited IRAs can be complex, but the following breakdown highlights the essentials. See the images below for a clear overview of how these rules apply in different situations.
Tax laws surrounding an inherited IRA are often complex and can be confusing, especially if the named beneficiary is not a spouse. The general rule of thumb is that distributions from an inherited Roth IRA are tax-free, while distributions from an inherited traditional IRA are subject to income tax. It is important to review IRS publications regarding inherited IRAs for clear guidance, as the rules can vary depending on the type of beneficiary. According to the IRS and the 10-year rule, all distributions must be made by the end of the tenth year following the account holder’s death, except for certain eligible designated beneficiaries. Inherited IRAs are typically considered part of the deceased’s estate, and distributions are generally taxed as income.
In most cases, an inherited Roth IRA is subject to the same required minimum distribution (RMD) rules as an inherited traditional IRA. Distributions or withdrawals are generally tax-free, but if the withdrawal comes from earnings, it may be subject to state income tax if the Roth IRA is less than five years old at the time of withdrawal. It is also important to note that distributions from another Roth IRA cannot be used as a replacement for distributions from an inherited Roth IRA unless the other account is also inherited and from the same descendant.
If you are named as a beneficiary on a retirement account, it is recommended that you consult with a CPA or financial advisor to determine the best course of action. In addition, reviewing the Secure Act can provide helpful details about inherited IRA rules and regulations and assist you in understanding how to navigate a self-directed IRA.
Planning for what happens to your self-directed IRA after your passing is just as important as managing it during your lifetime. The rules for inherited IRAs, whether traditional or Roth, can be complex, and they differ based on whether the beneficiary is a spouse, non-spouse, or entity. Understanding required minimum distributions, the SECURE Act’s 10-year rule, and the tax implications of inherited accounts ensures that your legacy is transferred efficiently and with as little burden as possible. By taking the time to review your estate plan, clearly naming beneficiaries, and consulting with a qualified tax or financial professional, you can give your loved one’s clarity and confidence in managing the assets you have worked hard to build.