No matter the account balance, an inherited individual retirement account is a generous gift — but it could also be a headache if a web of rules isn’t followed properly.
The first thing beneficiaries of any age need to know is how the money must be distributed, and that largely depends on the relationship to the gifter.
Two questions: Who is the spouse? Age of the deceased?
Spouses have three options, according to the Internal Revenue Service: They can name themselves as owner of the IRA and treat the account as their own; they may roll the assets into another account, such as a traditional IRA or qualified employer plan (where allowed); or they could continue to act as beneficiary of the account.
In all cases, they can change how the money is invested.
Then there’s another wrinkle: was the deceased already 72 years old, when account holders must make withdrawals — or younger?
Spousal beneficiaries may take ownership of the original IRA if the husband or wife hadn’t already turned 72. The big advantage to this strategy is delaying required minimum distributions, or RMDs, until the surviving spouse hits age 72 if the money isn’t needed earlier. But the spouse would need to be the only beneficiary in this scenario, not, for example, the spouse and children.
In the first scenario, the money would still grow tax-free, with an option to withdraw funds without penalty after turning 59 ½, just as if the widow or widower had opened the account. Spousal beneficiaries also can name new beneficiaries who would inherit anything left in the account after they die.
A second option when the deceased hadn’t yet turned 72 is to move the money into an “inherited IRA,” which would prompt RMDs either in the year when the deceased would have turned age 72, or Dec. 31 of the year after death, whichever is later. As in the first strategy, those required minimum distributions are based on the new owner’s life expectancy.
If, on the other, the decedent was 72 or older, the surviving spouse can take ownership of the account and follow the same rules as in the first option.
But if the money is instead rolled into an inherited IRA, the new owner must take required minimum distributions based on their own life expectancy by Dec. 31 of the year after the grantor died. This is different than with IRA owners who died before turning 72, where the widow or widower can wait until the original account holder would have turned 72 and been required to take distributions.
Spouses are exempt from the 10-year time limit to drain the account, as are beneficiaries of decedents who died before 2020 (because they can follow the pre-Secure Act distribution rules). Also exempt from the rule are beneficiaries who are children who have not yet reached the age of majority, disabled or chronically ill individuals, and beneficiaries who are no more than 10…
Read More: You inherit an IRA — what to do and how not to mess up