When a loved one dies and names you as the beneficiary of their retirement plan, you may inherit an account called an “Inherited IRA“.
This type of account makes it possible to transfer the assets of a deceased Individual Retirement Account (IRA) to a beneficiary, while maintaining tax benefits to some extent.
But beware: the rules vary considerably depending on your relationship with the deceased, and can have a major impact on your retirement planning and tax obligations.
Inheriting an IRA: An act of importance and responsibility
Receiving an inheritance via an Inherited IRA is often seen as a gesture of trust. It’s a way for the deceased to pass on a portion of his or her retirement savings to someone he or she feels is worthy of continuing to grow or benefit from them.
But unlike other forms of inheritance, inheriting an IRA involves strict rules, particularly with regard to mandatory withdrawals and taxation.
An Inherited IRA does not allow new contributions. It is an account dedicated to the management of sums transferred after the death of the original owner.
As beneficiary, you have a number of options to choose from, depending mainly on your relationship to the deceased.
Spouse vs non-spouse: Two very different paths
If you are the surviving spouse
Beneficiary spouses have almost total flexibility. You can :
- Transfer the IRA into your own retirement account, allowing you to treat it as your own IRA. You will then be subject to the same rules as for a Traditional IRA, including Required Minimum Distributions (RMDs) from age 73.
- Keep the IRA as an Inherited IRA: In this case, mandatory withdrawals will depend on the age of the deceased and your own life expectancy. This option may be advantageous if you are under 59 and wish to avoid the 10% penalty on early withdrawals.
- Withdraw all funds at once: Beware, this option can generate a hefty tax bill, especially if it’s a Traditional IRA.
If you are a non-spouse beneficiary
Since the SECURE Act took effect in 2020, the rules have tightened. In general, you must:
- Open an Inherited IRA in your name.
- Empty the account within 10 years of the year following the death of the original owner.
- Comply with annual RMDs if the deceased was already subject to mandatory withdrawals.
However, there is a category called Eligible Designated Beneficiaries (EDB), which benefits from relaxed rules. It includes:
- The owner’s minor children (up to the age of 21).
- Disabled or seriously ill beneficiaries.
- Beneficiaries less than 10 years older than the deceased.
These beneficiaries can spread withdrawals over their life expectancy, which limits the tax impact.
Tax implications: Between strategy and pitfalls to avoid
Inherited IRAs retain the tax treatment of the original account. For a Traditional IRA, each withdrawal is taxed as ordinary income, but for a Roth IRA, withdrawals are generally tax-free, provided the account has been open for at least 5 years.
Early withdrawals (before age 59 and a half) are not penalized in an Inherited IRA, unlike Traditional IRAs.
However, failure to comply with distribution rules (notably RMDs) may result in a tax penalty of 25%, or 10% if the error is corrected within two years.
A key stage in the transfer of assets
Inheriting an IRA should not be taken lightly. On the initial owner’s side, it is essential to anticipate this transmission within the overall framework of his or her retirement and succession. This means:
- Clearly designating beneficiaries on official forms.
- Updating these designations after marriage, divorce or death.
- Considering partial conversions to Roth IRAs to reduce taxation for heirs.
On the beneficiary’s side, it is crucial to:
- Understand the rules applicable to their situation to avoid costly mistakes.
- Optimize the withdrawal strategy according to your tax situation.
- Consult a financial or tax advisor, especially in the case of a large or complex inheritance.
Inheriting an IRA: Between opportunity and vigilance
An Inherited IRA can be a powerful lever for wealth transfer and an important complement to your retirement planning. But it requires rigor, anticipation and, often, professional guidance.
Whether it’s a question of growing capital or carefully managing a family inheritance, the complex rules must not obscure what’s essential: The desire to build a bridge between generations through enlightened management of retirement savings.
IRAs FAQs
An IRA (Individual Retirement Account) allows you to make tax-deferred investments to save money and provide financial security when you retire. There are different types of IRAs, the most common being a traditional one – in which contributions may be tax-deductible – and a Roth IRA, a personal savings plan where contributions are not tax deductible but earnings and withdrawals may be tax-free. When you add money to your IRA, this can be invested in a wide range of financial products, usually a portfolio based on bonds, stocks and mutual funds.
Yes. For conventional IRAs, one can get exposure to Gold by investing in Gold-focused securities, such as ETFs. In the case of a self-directed IRA (SDIRA), which offers the possibility of investing in alternative assets, Gold and precious metals are available. In such cases, the investment is based on holding physical Gold (or any other precious metals like Silver, Platinum or Palladium). When investing in a Gold IRA, you don’t keep the physical metal, but a custodian entity does.
They are different products, both designed to help individuals save for retirement. The 401(k) is sponsored by employers and is built by deducting contributions directly from the paycheck, which are usually matched by the employer. Decisions on investment are very limited. An IRA, meanwhile, is a plan that an individual opens with a financial institution and offers more investment options. Both systems are quite similar in terms of taxation as contributions are either made pre-tax or are tax-deductible. You don’t have to choose one or the other: even if you have a 401(k) plan, you may be able to put extra money aside in an IRA
The US Internal Revenue Service (IRS) doesn’t specifically give any requirements regarding minimum contributions to start and deposit in an IRA (it does, however, for conversions and withdrawals). Still, some brokers may require a minimum amount depending on the funds you would like to invest in. On the other hand, the IRS establishes a maximum amount that an individual can contribute to their IRA each year.
Investment volatility is an inherent risk to any portfolio, including an IRA. The more traditional IRAs – based on a portfolio made of stocks, bonds, or mutual funds – is subject to market fluctuations and can lead to potential losses over time. Having said that, IRAs are long-term investments (even over decades), and markets tend to rise beyond short-term corrections. Still, every investor should consider their risk tolerance and choose a portfolio that suits it. Stocks tend to be more volatile than bonds, and assets available in certain self-directed IRAs, such as precious metals or cryptocurrencies, can face extremely high volatility. Diversifying your IRA investments across asset classes, sectors and geographic regions is one way to protect it against market fluctuations that could threaten its health.
Information on these pages contains forward-looking statements that involve risks and uncertainties. Markets and instruments profiled on this page are for informational purposes only and should not in any way come across as a recommendation to buy or sell in these assets. You should do your own thorough research before making any investment decisions. FXStreet does not in any way guarantee that this information is free from mistakes, errors, or material misstatements. It also does not guarantee that this information is of a timely nature. Investing in Open Markets involves a great deal of risk, including the loss of all or a portion of your investment, as well as emotional distress. All risks, losses and costs associated with investing, including total loss of principal, are your responsibility. The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of FXStreet nor its advertisers. The author will not be held responsible for information that is found at the end of links posted on this page.
If not otherwise explicitly mentioned in the body of the article, at the time of writing, the author has no position in any stock mentioned in this article and no business relationship with any company mentioned. The author has not received compensation for writing this article, other than from FXStreet.
FXStreet and the author do not provide personalized recommendations. The author makes no representations as to the accuracy, completeness, or suitability of this information. FXStreet and the author will not be liable for any errors, omissions or any losses, injuries or damages arising from this information and its display or use. Errors and omissions excepted.
The author and FXStreet are not registered investment advisors and nothing in this article is intended to be investment advice.
