What Can You Do With an Inherited IRA?

Inheriting an Individual retirement account (IRA) can bring a mix of emotions, from the sadness of loss to the financial implications of the inheritance. If you are a beneficiary of an inherited IRA, it’s crucial to understand your options to maximize its benefits while ensuring compliance with tax regulations. Here’s a comprehensive guide on what you can do with an inherited IRA.

Types of Inherited IRAs

Before diving into what you can do with an inherited IRA, it’s important to understand that there are two primary types of inherited IRAs:

1. Inherited Traditional IRA: This type retains the tax-deferred status, meaning taxes are owed on withdrawals.

2. Inherited Roth IRA: Contributions to a Roth IRA are made with after-tax dollars, so qualified withdrawals are generally tax-free.

Your Options as a Beneficiary

The actions you can take with an inherited IRA depend on your relationship to the deceased (spouse, child, etc.) and whether the IRA was a traditional or Roth IRA.

1. Spousal Beneficiaries

If you inherit an IRA from your spouse, you have several options:

• Treat it as Your Own: You can treat the inherited IRA as your own, rolling it into your own IRA. This means that you will not have to take required minimum distributions (RMDs) until you turn 73 (as of 2023), allowing the funds to grow tax-deferred.

• Inherited IRA: If you choose to keep it as an inherited IRA, you will need to start taking RMDs based on your life expectancy.

2. Non-Spousal Beneficiaries

If you’re not the spouse, the rules differ:

• Open an Inherited IRA: You can transfer the assets into an Inherited IRA. This option allows you to grow the money tax-deferred and take RMDs based on your life expectancy, but you must start making withdrawals by December 31 of the year following the account holder’s death.

• Withdraw the Funds: You can also choose to withdraw the entire balance at once or over time. However, if you take a lump sum, it may have tax implications since the money will be added to your taxable income for that year.

Required Minimum Distributions (RMDs)

Under the SECURE Act, if the original account holder passed away after December 31, 2019, non-spousal beneficiaries typically must withdraw and close the Inherited IRA within 10 years. There are exceptions for certain eligible designated beneficiaries (EDBs), such as disabled individuals or minor children, who can take distributions over their life expectancy.

Tax Implications

Understanding the tax implications when dealing with an inherited IRA is critical:

• Traditional IRA: Distributions are taxed as ordinary income. Be mindful of how withdrawals could impact your tax bracket.

• Roth IRA: Distributions are generally tax-free for qualified withdrawals, but RMDs still apply as per the guidelines.

Investment Choices

Regardless of your option, you’ll have some flexibility in choosing how the inherited IRA funds are invested. You can usually invest in a range of assets, such as stocks, bonds, mutual funds, and ETFs. Assess your risk tolerance and time horizon to create a diversified portfolio that aligns with your financial goals.

Conclusion

Inheriting an IRA can provide valuable financial benefits, but making the right decisions is crucial. Consider your options carefully, consult with financial and tax professionals, and take the necessary steps to ensure compliance with IRS regulations. By understanding what you can do with an inherited IRA, you can make informed choices that benefit your financial future.

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