What we’ll cover:
If you’re inheriting an IRA, you may be wondering about your options when it comes to managing the money that’s in the account.
There’s a complex set of rules that determines what a beneficiary (that’s you) is allowed and not allowed to do with the inheritance. These rules became a little more complex with the passage of the SECURE Act in December 2019, a law that has brought significant changes to the nation’s retirement system. Many of the changes apply to retirement accounts inherited on or after January 1, 2020.
We understand that trying to navigate through these rules can be difficult, and it’s probably the last thing you want to do after the passing of a loved one. But this isn’t something you have to figure out on your own.
In this article, we’ll review some of the options you may have when you inherit an IRA. Hopefully, this overview can help you find your bearings and get a conversation going with your financial and tax advisors, who can discuss your options (and how they might impact your taxes) with you in more detail.
When you inherit an IRA, it usually means that someone has named you as a beneficiary on their account. Your range of options depends, in part, on your relationship with the original account owner and when they passed away.
For the purpose of this article, we’re going to assume that you’re the sole primary beneficiary of the IRA (translation: you’re not expected to share the funds with anyone else) and that you inherited the account after January 1, 2020. This helps us to keep things simple as we take a look at what you could do with the money.
Generally speaking, depending on your relationship with the original account owner (e.g., spouse vs. non-spouse), you may be able to do the following with your inherited account:
If you get the feeling that things are about to get a little complicated, don’t worry – we’ll break it down for you.
This option is available to anyone who is inheriting an IRA. Taking a lump-sum distribution means that you’re going to withdraw all the funds at once from the account you’ve inherited.
You won’t have to pay the typical 10% early withdrawal penalty for cashing out of the account. But if you’re cashing out a traditional IRA (which is a tax-deferred account), you usually have to pay federal income taxes on the money you’ve withdrawn. State and local income taxes may also apply depending on where you live.
For a Roth IRA, generally, the money you take out won’t be subject to taxes as long as the account has been opened for at least five years.
If you’re not sure whether you’ll owe any taxes, it’s a good idea to talk to a tax advisor to understand your potential tax obligations.
This option is only available to spousal beneficiaries – in other words, those who have inherited the IRA from their husband or wife.
With this option, you could transfer the inherited funds into an existing IRA that’s in your own name. If you don’t have your own account, you could open an IRA through most banks, brokerage firms or other IRA providers.
By rolling the money over to your own account, you’re essentially able to treat the funds as if they were your own to begin with. For example, if you wanted to make a withdrawal after the transfer, you would be subject to the same distribution rules that normally apply to any IRA.
For more information on distributions from IRAs, see IRS Publication 590-B.
This option is available to “eligible designated beneficiaries,” which generally include the following, according to the SECURE Act of 2019:
An Inherited IRA (or “Beneficiary IRA”) is a special type of account set up to receive and hold the funds transferred from a retirement account you’ve inherited.
An important distinction for this type of IRA: You cannot make any new contributions to the account. In other words, while you can transfer the inherited funds into the account, you may not put any of your own personal money in there.
By transferring the money into an Inherited IRA, eligible designated beneficiaries could take required minimum distributions (RMDs) based on their own life expectancy (see the IRS Uniform Lifetime Table which is used to calculate RMDs).
Why is this important?
Assuming you’re younger than the original IRA owner who passed away, this generally means your RMD amounts would be lower than what the original owner had to take. By stretching the RMDs over your life expectancy, it would essentially give the funds in the account more time to potentially grow.
Keep in mind that your RMD obligations depend on several factors, such as your relationship with the deceased and whether the deceased had already started taking RMDs prior to their passing.
Figuring out your RMDs is no easy task, and this is definitely something you want to check in with a tax advisor who can guide you through the calculations. If you’re curious, here’s the hefty reading on RMD rules from the IRS. Fair warning: It’s not a fun read.
Bear in mind that if you don’t take RMDs on time or in the correct amounts, you could end up paying costly penalties. How much are we talking about? As much as 50% of your original RMD amount!
If you’re not one of the “eligible designated beneficiaries” that we mentioned in the previous section, you could still transfer the money you’ve inherited into an Inherited IRA. However, you’re generally required, by the SECURE Act, to distribute all the funds in the account within 10 years of the original IRA owner’s passing.
In other words, you’re not allowed to “stretch” your distributions over your lifetime.
You could decide to distribute the funds all at once or do so gradually over the 10-year window. But how you choose to take out the money could impact your tax situation, so, once again, be sure to work with your tax advisor to figure out a strategy that makes sense for you.
This option is available to anyone who is inheriting an IRA – regardless of your relationship with the original account owner.
Under this option, you may disclaim (or give up the rights to) the inheritance. If there is a contingent (also referred to as “secondary”) beneficiary named on the account, then the money would be passed on to them instead.
But what if there isn’t a secondary beneficiary? Where the money goes will depend on the details of the IRA custodial agreement. If you’ve disclaimed the account, you, yourself, cannot name someone else as a beneficiary or control where the money goes. (This is a good reminder of why estate planning is important).
If you don’t plan on accepting the account, you have to disclaim it within 9 months of the original account owner’s passing (and you cannot have used or accepted any of the money prior to disclaiming it).
Giving up your rights to an inheritance is a big decision, and it comes with many rules. In general, you can’t disclaim an account and then change your mind later down the road. This is why it’s important to speak with a tax advisor or attorney before going forward.
Inheritances often come with a mixed bag of emotions, and making financial decisions during an emotionally-charged time can be challenging.
When you inherit an IRA, you may be able to manage the money in a few different ways. Each option comes with its own set of rules and tax implications – the details can be complex depending on your personal situation.
Don’t be shy about asking for help from a professional financial or tax advisor; they can sit down with you to determine a course of action that’s right for you.
This article is for informational purposes only and is not a substitute for individualized professional advice. Individuals should consult their own tax advisor for matters specific to their own taxes and nothing communicated to you herein should be considered tax advice. This article was prepared by and approved by Marcus by Goldman Sachs, but does not reflect the institutional opinions of Goldman Sachs Bank USA, Goldman Sachs Group, Inc. or any of their affiliates, subsidiaries or division. Goldman Sachs Bank USA does not provide any financial, economic, legal, accounting, tax or other recommendation in this article. Information and opinions expressed in this article are as of the date of this material only and subject to change without notice. Information contained in this article does not constitute the provision of investment advice by Goldman Sachs Bank USA or any its affiliates. Neither Goldman Sachs Bank USA nor any of its affiliates makes any representations or warranties, express or implied, as to the accuracy or completeness of the statements or any information contained in this document and any liability therefore is expressly disclaimed.