What Happens to an Inherited IRA When the Beneficiary Dies

When a beneficiary dies, the inherited IRA is subject to income tax on the entire balance, which can be a significant tax burden for the estate. This is because the beneficiary never had control over the IRA and was only responsible for taking required minimum distributions (RMDs) starting at age 72.

The tax implications of inheriting an IRA can be complex, and the beneficiary's estate may be responsible for paying taxes on the entire balance, regardless of whether the IRA was distributed or not. This can lead to a large tax bill, which can be difficult to pay.

The beneficiary's estate will need to file a tax return and report the distribution of the IRA, which will trigger a tax liability. The estate will also need to pay any applicable penalties for not taking RMDs.

For more insights, see: Tax on Inherited Ira Withdrawal

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

You can also open an inherited Roth IRA using the life expectancy method or the 10-year method. With the life expectancy method, RMDs will be mandatory, but you can postpone these distributions until the later of two options: when your spouse would have turned 72 or the end of the year following their death.

To qualify for a spousal transfer, you must be the sole beneficiary of the IRA. If you're not a spouse, you'll need to follow different rules.

Here are the different options for non-spouse beneficiaries:

The type of IRA you inherit and your relationship to the deceased will determine which options are available to you.

If the deceased was under 72 years old, you can choose from all three options. If they were 72 or older, your options are limited to the life expectancy method or a lump-sum distribution.

Eligible designated beneficiaries include:

Under the final IRS rules, some beneficiaries will need to take annual distributions throughout the 10 years. The RMD amount each year can vary based on several factors, including the beneficiary's age, relationship to the deceased, and the value of the inherited account.

Here's a breakdown of the distribution rules:

Note that individual circumstances vary, so it's essential to consult with a trusted tax advisor to determine how to time your distributions strategically while complying with the 10-year rule if it applies to you.

A spouse or eligible beneficiary can treat an inherited IRA as their own, but others cannot.

If you're not a spouse or eligible beneficiary, you have two options: transfer your portion of the assets into a new IRA or withdraw all the money immediately.

You can transfer your portion of the assets into a new IRA, which must be set up and formally designated as an inherited IRA.

To withdraw all the money immediately, you must open an Inherited IRA in your name first.

Roth IRA withdrawals can be made without taxation if the account has been open for at least five years and the beneficiary is over 59 ½.

Spousal and non-spousal beneficiaries have similar rules when it comes to inheriting an IRA.

Explore further: Spousal Rollover Ira

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 age 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.

To be considered a non-spouse eligible designated beneficiary, you must be a minor child of the deceased account holder, chronically ill or disabled, or not more than 10 years younger than the deceased beneficiary.

If the deceased was 72 years of age or over, your withdrawal options are limited to opening an inherited IRA using the life expectancy method or taking a lump-sum distribution.

Non-spousal beneficiaries have two main options: they can transfer their portion of the assets into a new IRA, which must be set up and formally designated as an inherited IRA, or they can withdraw all the money immediately as a single lump sum.

Related reading: 457 Plan Withdrawal Age

Here are the steps to take a lump sum distribution:

Keep in mind that if you opt for the lump sum, you won't face the tax penalty most people incur for withdrawing IRA funds before the age of 59 ½, but you would still owe income tax on any withdrawals or RMDs made from pre-tax IRA accounts.

For non-spousal beneficiaries, all distributions must be completed within 10 years after the account holder dies.

Broaden your view: Inherited Ira Tax Strategies

You can assume ownership of your spouse's Roth IRA by a spousal transfer, but the earnings will generally be taxable until you reach age 59½ and meet the five-year holding period.

If you're the sole beneficiary, you can choose from three options: the life expectancy method, the 10-year method, or a lump-sum distribution.

With the life expectancy method, you'll have to take mandatory RMDs, but you can postpone them until your spouse would have turned 72 or the end of the year following their death.

Consider reading: Inherited Ira for Spouse

The 10-year method allows you to keep the money available at any time until the end of the tenth year after your spouse died, at which point all the money must be distributed.

If you use the 10-year method and the five-year holding period has been met, you can take distributions during that period without being taxed, and you won't incur the 10% early withdrawal penalty.

A lump-sum distribution is another option, where all assets will be distributed to you immediately, and earnings will be taxable if the account was less than five years old when your spouse died.

Worth a look: What Happens If an Executor of a Will Dies?

Understanding IRAs can be a complex topic, but it's essential to grasp the basics. Individual retirement accounts can be passed on to beneficiaries after you die.

An IRA can be inherited by anyone, including estates or trusts, but spouses have more flexibility when it comes to withdrawing and accessing the funds. Any type of IRA, such as traditional, Roth, rollover, SIMPLE, or SEP IRAs, can be inherited.

Tax rules for an inherited IRA can be complicated, so it's a good idea to seek professional help if needed.

A unique perspective: Withdrawal from 457 Plan

If you're looking for guidance on what happens to an inherited IRA when the beneficiary dies, it's essential to understand the rules and regulations surrounding these accounts.

According to the Internal Revenue Service, a beneficiary is responsible for managing the inherited IRA after the original account owner's death.

The SECURE Act, which went into effect in 2020, changed the rules for inherited IRAs, including the stretch IRA rule. As explained by Edward Slott in his article "Did the SECURE Act Kill the Stretch IRA?", the new law limits the time beneficiaries have to take distributions from the inherited IRA.

A beneficiary can choose to take a lump sum distribution, which may be subject to taxes, or they can take annual required minimum distributions (RMDs) based on their own life expectancy. As stated in the article "Inheriting an IRA? Understand Your Options" by Hank Adams, beneficiaries have the flexibility to choose how they take distributions.

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However, it's worth noting that the SECURE Act created exceptions to the rule, allowing certain beneficiaries to continue taking RMDs based on the original account owner's life expectancy. According to a Kiplinger article by Tony Barrett, "Who Can Still Do a Stretch IRA after the SECURE Act: Explaining the Exceptions to the Rule", these exceptions apply to beneficiaries who are disabled, chronically ill, or no more than 10 years younger than the original account owner.

Here is a summary of the distribution options for inherited IRAs:

It's essential to consult with a qualified professional to determine the best course of action for your specific situation.