If you have inherited an individual retirement account (IRA) from a parent or any other relative, you do not need to turn the account over to the estate, even if the will says otherwise.
Learn more about the rules for inheriting retirement accounts like IRAs, including how they are typically taxed and rules for making withdrawals.
Key Takeaways
- Named beneficiaries to an inherited IRA supersede any provision in a will.
- Because traditional IRAs are tax-deferred assets, taxes are not paid until the beneficiary takes a distribution from the account.
- IRA distributions are considered taxable income, and they are not included in “cash-in-hand” when executing a will.
- Typically, inherited IRAs must be liquidated within 10 years.
Beneficiaries
The designation of a primary beneficiary for an IRA is important. Whether you want to leave your traditional or Roth IRA account to your spouse or your children, you must designate them as beneficiaries. You should also keep your IRA beneficiary list up to date as your family circumstances change.
Assets that pass by beneficiary designation are not probate assets and are not subject to the terms of the will. An IRA account is a common example of an asset that is not a probate asset, said Michael Delgass, Managing Director of Wealthspire Advisors. “These assets have a contractual agreement with the entity holding them that requires that entity to pay them out to the beneficiary,” he said.
Inherited IRA distribution rules will vary depending on whether or not the IRA is inherited from a spouse or non-spouse. If you inherit an IRA from your spouse, it can have the same distribution rules as your own personal IRA.
Important
An IRA inherited from someone other than your spouse may have other distribution rules and policies.
Options for Funds Inherited From an IRA
When you inherit an IRA, you can either remove the money from the account in a lump sum or roll the money into an “inherited IRA” in your name and take withdrawals over 10 years. (The 10 year time period begins December 31 of the year following the death of the accountholder.)
Traditional IRAs and inherited traditional IRAs are tax-deferred accounts. That means that income tax is charged on the distributions because the deposits were make with pre-tax money. Typically, you must take required minimum distributions (RMDs) if the original accountholder already started taking them.
With Roth IRAs, you do not pay taxes on withdrawals on the deposits as the deposits were made with after-tax funds. If the inherited Roth IRA account is more than five years old, you can also withdraw earnings tax-free. You will not have to take required minimum distributions.
If you are the beneficiary of a Roth IRA, consider rolling the funds to an inherited IRA and postponing making withdrawals until the end of the 10-year time period. That way, you could allow the investments to grow then withdraw the earnings tax-free.
Cash on Hand
If the will asks for “cash on hand” to be distributed among family members, this does not include funds you inherit from an IRA account. You are not required to provide the executor with the proceeds from the IRA. The beneficiary designation supersedes any provision in the will. A beneficiary designation takes precedence over terms listed in a will.
“Cash on hand refers to readily accessible cash, and since [traditional] IRA distributions are taxable, I would personally not include that in cash on hand,” said Adam Harding, a financial advisor in Scottsdale, Arizona.
Frequently Asked Questions (FAQs)
Do Inherited Roth IRAs Have to be Distributed Within 10 years?
You must liquidate an inherited Roth IRA within 10 years of inheriting it, which is known as the 10-year rule. You are not required to take minimum distributions during this time.
How Much Tax Will I Pay if I Cash Out an Inherited IRA?
Whether you will have to pay taxes on an inherited IRA will depend on the type of IRA and how old it is. You can make withdrawals from a Roth IRA tax-free at any time in the amount of your deposits. But to withdraw earnings on your investments without paying tax, the Roth IRA must be at least five years old. You will pay income tax on withdrawals from a traditional IRA.
What Is the 5-Year Rule for Inherited Roth IRA Distribution?
The 5-year rule for inherited tax advantaged retirement accounts, including Roth IRAs, states that if you are the beneficiary of an IRA, you must withdraw all the funds by the fifth year following the original account holder’s death. However, you are not required to take withdrawals during that time. This 5-year rule was common before 2020. Now, beneficiaries have 10 years to make the withdrawals.
The Bottom Line
Keep your inherited IRA and be aware of distribution policies and taxes on those distributions. Inherited IRAs either need to be distributed within five years of receiving them, or that time period can be extended so that inherited assets can be distributed over the beneficiary’s life expectancy. In either case, distribution from an inherited IRA is considered income and taxed accordingly.
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