Inherited IRA Basics and Tax Implications

Inherited IRAs can be a complex and overwhelming topic, but understanding the basics can help you navigate the process with ease. You can inherit an IRA from a spouse, parent, or other eligible family member.

To qualify for an inherited IRA, the original owner must have passed away, and you must be the beneficiary of the account. This means you'll need to provide the IRA custodian with proof of the original owner's death and your relationship to them.

You'll have several options for managing the inherited IRA, including taking a lump sum distribution, rolling it over to your own IRA, or taking annual required minimum distributions (RMDs). The type of distribution you choose will depend on your individual circumstances and the type of IRA you're inheriting.

The tax implications of inherited IRAs can be significant, and it's essential to understand the rules surrounding RMDs and distributions.

A unique perspective: Rules for Custodial Roth Iras

An inherited IRA is a type of retirement account that is passed down to a beneficiary after the original account owner's death.

Readers also liked: High Dividend Stocks to Ira or Brokerage Account

The account owner must have died before their required minimum distribution (RMD) age, which is typically 72 years old, to qualify for an inherited IRA.

Beneficiaries of an inherited IRA can be a spouse, child, grandchild, or other eligible family member.

Inherited IRAs are subject to specific rules and regulations, including the requirement that beneficiaries take RMDs by December 31st of each year.

The beneficiary of an inherited IRA must take a lump-sum distribution within five years of the account owner's death, unless the beneficiary is the account owner's spouse.

You'll need to pay taxes on withdrawals from an inherited traditional IRA, which will be taxed as ordinary income. This means you'll need to report the withdrawal on your tax return and pay taxes on it at your marginal tax rate.

If you inherit a traditional IRA, any amount you withdraw is subject to ordinary income taxes. This can be a significant tax burden, but you might be able to offset some of the taxes with an estate tax deduction.

For estates worth more than $13.99 million in 2025, you'll need to consider the estate tax implications of inheriting an IRA. This means you might get an income-tax deduction for the estate taxes paid on the account, which can help reduce your taxable income.

Broaden your view: Do You Have to Report Rollover Ira on Taxes

Calculating RMDs can be a complex process, but understanding the rules can help you avoid penalties. The RMD rules for inherited IRAs vary depending on the relationship of the beneficiary to the original account holder and when the account holder passed away.

If you inherit an IRA, you'll need to set up an IRA beneficiary distribution account (BDA) with a financial institution to receive and manage the inherited IRA assets according to IRS regulations. The RMD amount is calculated each year based on the account balance at the end of the previous year divided by a life expectancy factor from the IRS Single Life Expectancy Table.

For nonspouse beneficiaries, the life expectancy factor decreases each year, reflecting a shorter remaining life expectancy. For example, the beneficiary would use their age in the year after death to determine this figure, then subtract 1 for each subsequent year.

Spousal beneficiaries have more flexible options, including treating the IRA as their own or continuing it as an inherited IRA. If you're a beneficiary, it's crucial to understand and follow these rules to avoid potential penalties.

Here's a summary of the RMD rules for nonspouse beneficiaries:

Remember, the RMD rules can be complex, and it's essential to consult with a tax advisor to ensure you're meeting the requirements.

If you're inheriting an IRA, you may be eligible for a tax break, which can significantly reduce your tax burden.

For starters, if you inherit a Roth IRA, you're free of taxes, but with a traditional IRA, any amount you withdraw is subject to ordinary income taxes.

The estate tax can also impact your tax break, and for 2025, estates worth more than $13.99 million are subject to the estate tax, up from $13.61 million in 2024.

You can get an income-tax deduction for the estate taxes paid on the IRA, which can be a huge help if you're inheriting a large estate.

This deduction can be applied to the taxable income earned by the IRA, but not received by the deceased, known as "income in respect of a decedent."

Here's an interesting read: Do You Pay Taxes on Roth Ira Capital Gains

For example, if the IRA earned $1 million in income, but the estate paid $350,000 in estate taxes, you might have a $1 million income with a $350,000 deduction to offset against that.

This can make a big difference in your tax liability, and it's not necessary that you were the person who paid the taxes, just that someone did.

Suggestion: Capital Gains Taxes on Inherited Property

Inherited IRAs come in three main types: spousal inherited IRAs, nonspousal inherited IRAs, and non-person inherited IRAs. Each type has its own rules and regulations.

Spousal inherited IRAs offer flexibility, allowing the surviving spouse to choose between remaining the beneficiary or assuming ownership of the IRA. This means they can continue to defer taxes on the account until they make distributions.

Nonspousal inherited IRAs, on the other hand, are more restrictive. Beneficiaries, such as children or friends, cannot treat the inherited IRA as their own, and they're generally required to take distributions from the account. The SECURE Act of 2019 modified the distribution requirements, requiring nonspouse beneficiaries to withdraw all assets from an inherited IRA within 10 years after the death of the original owner.

Here are the main differences between the three types of inherited IRAs:

Understanding the type of inherited IRA and its rules is crucial for managing the account properly and avoiding potential tax pitfalls.

If you inherit an IRA, it's essential to understand the type of account and the rules that come with it.

There are three main types of inherited IRAs: Spousal inherited IRA, Nonspousal inherited IRA, and Non-person inherited IRA.

A Spousal inherited IRA offers flexibility, allowing the surviving spouse to manage the account as their own or remain the beneficiary. The required minimum distribution (RMD) factor and timing can vary.

If the spouse elects to treat the proceeds as their own, the RMDs will be based on their age, but if they remain the beneficiary, the RMDs can be deferred until they would have been RMD age.

Nonspouse beneficiaries, on the other hand, cannot treat the inherited IRA as their own and are generally required to take distributions, which are subject to different rules.

Recent changes under the SECURE Act of 2019 have modified the distribution requirements for nonspouse beneficiaries, requiring them to withdraw all assets within 10 years after the death of the original owner.

Here are the key distinctions between the three types of inherited IRAs:

Understanding the type of inherited IRA and the rules associated with it is crucial for managing the account properly and avoiding potential tax pitfalls.

An inherited IRA offers several advantages, particularly in the realms of tax benefits, distribution flexibility, and potential for continued growth.

You can take advantage of tax benefits with an inherited IRA, which can help you save on taxes.

The distribution flexibility of an inherited IRA allows you to take distributions over your lifetime, rather than having to take them all at once.

This can be particularly helpful if you're not ready to take a large distribution from your inherited IRA.

A unique perspective: Rollover from 401k to Ira Tax Implications

Inherited IRAs also offer the potential for continued growth, which can help your savings grow over time.

This can be especially beneficial if you're not planning to use the funds from your inherited IRA for a while.

You should carefully review the rules for assets in your inherited IRA to ensure you're taking advantage of these benefits.

Rules surrounding inherited IRAs depend on your relationship to the deceased person and your age. If you're a non-spousal beneficiary, you'll need to take distributions from the account within 10 years of the original owner's death.

For non-spousal beneficiaries, you can't roll the inherited IRA assets into an existing IRA, and you can't contribute to an inherited IRA in the future. Assets must be transferred to a new inherited IRA account.

The 10-year rule applies to non-spousal beneficiaries, meaning you must withdraw all assets from the inherited IRA within 10 years after the death of the original owner. Recent changes under the SECURE Act have modified the distribution requirements, and RMD requirements may apply within the 10-year period as well.

Explore further: Inherited Ira 10-year Rule Example

Here are some key distinctions between the 3 types of inherited accounts:

In rare instances, retirement accounts might be left to a non-designated beneficiary, such as a charity or estate. The rules associated with these beneficiaries remain largely unaffected by the SECURE Act, as the distribution options are based on whether the owner died before reaching their required beginning date.

If you're inheriting an IRA from your spouse, you have several options to consider.

You can treat the IRA as your own, naming yourself as the owner, or roll it over into another account, such as another IRA or a qualified employer plan. This can be a great way to keep the account growing without having to take distributions.

If you choose to treat the IRA as your own, you may have to take Required Minimum Distributions (RMDs) depending on your age, or you may have to fully withdraw the money in 10 years. But in some cases, you may be able to let the money continue to grow in the IRA until you reach age 72.

Take a look at this: Reits in Ira Accounts

Spouses have the unique ability to roll over the inherited IRA assets into their own IRA and then convert that into a Roth IRA. This is allowed because spouses have the ability to treat inherited IRAs as their own.

You can also transfer the Roth IRA funds to your own IRA account, with all the same Roth rules governing contribution and distribution. This can be a good option if you want to keep contributing to your Roth and take distributions without paying penalties or taxes.

However, if you roll the inherited Roth assets into a new Roth account, you may not contribute to that IRA and must hold that account for five years before tapping into those funds. If you withdraw funds prior to the five-year period, you may be liable for a penalty on the earnings.

Here are some key options to consider for spousal beneficiaries:

Non-spouse beneficiaries, on the other hand, must use all of the funds in an inherited IRA within 10 years of the original IRA owner's death. If you're a non-spouse beneficiary, you may want to consider rolling the inherited IRA assets into a new IRA account to make it easier to manage the distributions and respective rules.

It's worth noting that converting an inherited IRA to a Roth IRA can result in a significant tax liability, potentially pushing the beneficiary into a higher tax bracket. However, this can be a good option if you expect to be in a higher tax bracket in the future or want to avoid Required Minimum Distributions (RMDs) and let the account grow tax-free for as long as possible.

If you're a spouse beneficiary, you're in luck - converting an inherited IRA to a Roth IRA is relatively straightforward. You can roll over the inherited IRA assets into your own IRA and then convert that into a Roth IRA.

However, if you're a nonspouse beneficiary, direct conversion isn't an option. You can distribute the funds, pay the necessary taxes, and then potentially invest those funds into a Roth IRA you already own, subject to annual contribution limits.

The primary advantage of converting to a Roth IRA is the tax-free growth and withdrawal benefits. Unlike traditional IRAs, Roth IRAs don't require minimum distributions during your lifetime, and qualified withdrawals are tax-free.

One major drawback of converting to a Roth IRA is the immediate tax liability. The converted amount is treated as taxable income in the year of the conversion, which can result in a significant tax bill.

Here are the conditions for conversion:

To help you make an informed decision, consider the following options:

A table to summarize the conversion options:

Remember, it's essential to explore the implications of each option and consult with a financial advisor to determine the best course of action for your specific situation.