Cashing Out an Inherited IRA: What You Need to Know

Cashing out an inherited IRA can be a complex and emotional process, especially if you're dealing with the loss of a loved one.

You'll need to decide whether to take a lump sum distribution or set up an inherited IRA account.

A lump sum distribution is typically taxed as ordinary income, with a 10% penalty for distributions taken before age 59 1/2, unless an exception applies.

You may also have the option to set up an inherited IRA, which can provide tax benefits and flexibility.

If you're inheriting an IRA, you'll want to know the basics. Inherited IRAs have their own set of rules that differ from traditional IRAs.

You'll need to understand the rules for taking Required Minimum Distributions (RMDs) from an inherited IRA. For minor children, the RMDs will be taken through a guardian until age 21, based on their life expectancy.

As a general rule, RMDs from traditional IRAs are taxed as ordinary income based on the beneficiary's tax bracket. But if the original owner held the account for at least five years, distributions from a Roth IRA aren't taxed.

Beneficiaries close in age to the deceased can take RMDs based on their own age, not the original owner's. This applies if they're within 10 years of the original account owner's age.

If the beneficiary is disabled or chronically ill, they can take RMDs based on their life expectancy. This includes being unable to work, cognitively impaired, or unable to perform basic functions of daily life.

Cashing out an inherited IRA can be a complex process, but understanding the tax implications can help you make informed decisions.

The tax treatment of inherited IRAs depends on the type of IRA owned by the deceased, as well as the type of beneficiary and withdrawal method selected. You should talk with your tax advisor or CPA before deciding how to proceed.

Inherited IRAs for non-spouses have two new stipulations to keep in mind: the heir has 10 years to empty the account, and withdrawals are taxed at the beneficiary's regular income rate. This can be a serious financial challenge, especially if you spread out the distributions over 10 years.

Additional reading: Tax on Cash Withdrawal

You can consider working with a financial advisor to create a plan that minimizes your taxes. This might involve making charitable donations or withdrawing more in years when your income - and thus your tax rate - is lower.

Most beneficiaries are subject to RMD rules for inherited IRAs, whether the account owner died before or after age 73. This means the account must be depleted within 10 years, unless you're a spouse beneficiary.

Here's a summary of the tax implications for inherited IRAs:

If you've inherited an IRA from your spouse, you're in luck - you can treat it as your own retirement account by naming yourself as the owner. This means you can roll over the funds into a qualified employer plan or a tax-sheltered annuity plan.

To be eligible, you must be the sole beneficiary of the IRA. If you're the sole beneficiary, you can roll over the funds into a qualified plan or your own IRA, and you won't have to take Required Minimum Distributions (RMDs) until you reach the age of 72.

If you roll over the funds, you'll need to take a distribution before age 59½, and you'll likely be subject to a 10% early withdrawal penalty. However, if you roll over the funds into a qualified plan or your own IRA, you can delay taking a distribution until you're 72.

If you inherit a traditional IRA from someone other than your spouse, your withdrawal options depend on the decedent's age at death. If the person was under 72, you can open an inherited IRA using the life expectancy method, the 10-year method, or take a lump sum distribution. If the deceased was 72 or over, your options are limited to opening an inherited IRA using the life expectancy method or taking a lump sum distribution.

Here are the key differences between spousal and non-spousal IRAs:

If you're a non-spousal beneficiary, you'll need to establish an inherited IRA and follow the 10-year rule, which requires you to distribute the funds within 10 years of the original owner's death. However, if you're a disabled, chronically ill, or minor child, you may be exempt from this rule.

On a similar theme: Inherited Ira 10-year Rule Example

If you inherit your spouse's traditional IRA, you can assume ownership of the IRA by a spousal transfer and treat it as your own retirement account. This allows you to defer Required Minimum Distributions (RMDs) until you reach 72, or 70½ if you reach 70½ before January 1, 2020.

You can also roll over the deceased's IRA into a qualified employer plan, qualified annuity plan, tax-sheltered annuity plan, or deferred compensation plan of a state or local government such as a 457(b). This can be a great way to manage your finances and avoid penalties.

If you roll over the funds into a qualified plan or your own IRA and take a distribution before 59½, you'll likely be subject to a 10% early withdrawal penalty. This is something to keep in mind when planning your finances.

You can roll over a distribution from your deceased spouse's IRA into an IRA of yours within a 60-day time limit, as long as the distribution is not a required distribution. This can be a helpful option if you need access to the funds quickly.

If you inherit your spouse's Roth IRA, you can assume ownership of the IRA by a spousal transfer, but the money will be available to you at any time and the earnings will generally be taxable until you reach 59½ and meet the five-year holding period.

If you're inheriting a retirement account from someone other than your spouse, you're considered a non-spousal beneficiary. This can be a complex and overwhelming process, but understanding the guidelines can help you make informed decisions.

To be considered an eligible designated beneficiary (EDB), you must meet specific criteria, including being a minor child of the deceased, chronically ill or disabled, or not more than 10 years younger than the deceased.

As an EDB, your withdrawal options depend on the decedent's age at death. If the person was under 72 when they died, you can open an inherited IRA using the life expectancy method, the 10-year method, or take a lump sum distribution. If they were 72 or older, your options are limited to opening an inherited IRA using the life expectancy method or taking a lump sum distribution.

Non-EDBs, on the other hand, have limited options. They can take a lump sum distribution, but this may lead to more taxable income. Alternatively, they can use the 10-year rule, where they must empty the account within 10 years of the original owner's death.

Recommended read: Cash Advance Options

Here are the key differences between EDBs and non-EDBs:

It's essential to note that the SECURE Act of 2019 has changed the rules for non-spousal beneficiaries. Before 2019, non-EDBs could use the Stretch IRA strategy, but this is no longer an option. Now, most non-EDBs who inherit an IRA on or after January 1, 2020, must empty the account within 10 years of the original owner's death.

Remember, understanding the guidelines for non-spousal beneficiaries can help you navigate the complex process of inheriting a retirement account. Take your time, and consult with a financial advisor if needed.

Cashing out an inherited IRA can be a complex process, but understanding the distribution rules can help you make informed decisions. The rules governing distributions from inherited IRAs can lead to some complex planning, and there are different distribution provisions depending on factors such as the beneficiary's relationship to the original owner and whether the original owner had reached their required beginning date (RBD).

If you're a non-spouse beneficiary, you'll typically be subject to a 10-year rule, which means you must withdraw the full balance of your inherited IRA by the end of the 10th year following the death of the original account owner. This can be a significant change, especially if you're used to stretching withdrawals over your lifetime.

You have three main options for depleting an inherited IRA: taking all the money at once, setting up regular withdrawals, or taking distributions whenever you want within the 10-year time frame. Taking all the money at once can increase your tax bracket for the year and miss out on potential tax-deferred growth in the account.

The 10-year rule applies to most beneficiaries, but there are some exceptions. If you're the owner's spouse or minor child, chronically ill, disabled, or up to 10 years younger than the owner was, you can stretch distributions over your lifetime. Additionally, if the IRA owner was at least age 73 when they died and hadn't yet taken an RMD for the year in which they died, you may need to take that distribution on their behalf.

Here are the three main options for depleting an inherited IRA:

It's essential to understand the nature of the changes and how they might affect your own plan and situation. You can knock down the 25% excise tax on the amount you failed to take to 10% if you empty the account within two years, thanks to the SECURE 2.0 Act.

The SECURE Act and other regulations can make inheriting an IRA more complicated. The SECURE Act of 2019 changed the rules for inherited retirement accounts, making it harder to plan ahead.

Before the SECURE Act, you generally needed to start taking RMDs by April 1st following the calendar year you turned 70½. Now, the RMD age is 72, and the age is scheduled to increase to 75 in 2033.

The SECURE Act also eliminated the Stretch IRA for non-EDBs and non-designated beneficiaries, forcing tax-free dollars out of inherited Roth IRAs sooner than previously required. This change applies to both Roth IRAs and pre-tax IRAs.

Here's an interesting read: Secure Act Inherited Ira