Navigating Inherited IRA Withdrawal Rules: What You Need to Know

Jan 15, 2025 | Retirement

If you’ve inherited an Individual Retirement Account (IRA), understanding the rules surrounding withdrawals is essential. The SECURE Act and SECURE Act 2.0 have introduced changes that impact how and when beneficiaries must withdraw funds. Whether you’re inheriting as a spouse, non-spouse, or eligible designated beneficiary, knowing your options and obligations can help you manage the account effectively and avoid costly penalties.

What Is an Inherited IRA?

An inherited IRA is a retirement account passed down to a designated beneficiary when the account holder dies. This includes both traditional IRAs and Roth IRAs. Once inherited, the account is subject to different rules regarding withdrawals compared to an IRA you establish for yourself. The treatment of an inherited IRA depends on your relationship to the deceased and the type of account you inherit. Changes introduced under the SECURE Act of 2019 and updated in SECURE Act 2.0 significantly influence withdrawal requirements.

The 10-Year Rule for Non-Spouse Beneficiaries

The SECURE Act of 2019 introduced the 10-year rule, which applies to most non-spouse beneficiaries. Under this rule, the inherited IRA must be fully distributed within 10 years of the original account holder’s death. The withdrawals can be taken at any time during this period, but the account must be emptied by the end of the 10th year. This rule applies to both traditional and Roth IRAs. For traditional IRAs, distributions are taxed as ordinary income, while Roth IRA withdrawals are typically tax-free if the account was open for at least five years.

One key change under SECURE Act 2.0 is the clarification of Required Minimum Distributions (RMDs) within the 10-year window. If the account holder had already started RMDs before their passing, beneficiaries must continue to take annual RMDs in years one through nine and empty the account by the 10th year.

Exceptions to the 10-Year Rule

Not all beneficiaries are subject to the 10-year rule. Eligible Designated Beneficiaries (EDBs) are exempt and can stretch withdrawals over their life expectancies, which are available as tables directly through the IRS website. This category includes:

  • Spouses of the deceased.
  • Minor children of the account holder (until they reach the age of majority).
  • Individuals who are chronically ill or disabled.
  • Beneficiaries not more than 10 years younger than the deceased.

These exceptions allow for greater flexibility, particularly for EDBs who can opt to take smaller annual withdrawals over time, reducing the immediate tax burden.

Spousal Options for Inherited IRAs

Spouses have unique advantages when inheriting an IRA. They can:

  1. Treat the IRA as their own: This option allows spouses to roll the inherited funds into their personal IRA, deferring RMDs until they turn 73 (or 75, depending on their birth year).
  2. Leave it as an inherited IRA: In this case, withdrawals are based on the spouse’s life expectancy, offering some flexibility in distribution timing.
  3. Use the 10-year rule: This may be advantageous in specific scenarios, such as when the spouse is younger and does not want to take immediate RMDs.

While these options are available both before 2025 and after 2024, there may be differences in the specific rules and RMD calculations applied to each period.

Tax Implications

Distributions from traditional inherited IRAs are taxed as ordinary income, potentially affecting your tax bracket. In contrast, Roth IRA distributions are generally tax-free, making them a more favorable inheritance option. It’s important to note that inherited IRAs do not allow for additional contributions, meaning any withdrawals permanently reduce the account balance.

Avoiding Penalties

Failing to comply with withdrawal requirements can result in steep penalties. For example:

  • Missed RMDs: As of 2023, the IRS imposes a 25% excise tax on any missed RMD amounts. If corrected promptly, this penalty may be reduced to 10%.
  • Failure to empty the account within 10 years: Triggers penalties assessed on the remaining balance.

By understanding and adhering to the rules, you can avoid unnecessary costs and preserve more of your inheritance.

Strategies for Managing an Inherited IRA

To make the most of an inherited IRA, consider these strategies:

  • Understand Your Beneficiary Type: Confirm whether you’re a spouse, non-spouse, or EDB, as this determines your withdrawal timeline and flexibility.
  • Consult a Financial Advisor: A professional can help you create a distribution strategy that aligns with your financial goals while minimizing tax liability.
  • Plan Withdrawals Strategically: For traditional IRAs, spreading distributions over several years may prevent you from being pushed into a higher tax bracket.
  • Stay Aware of Deadlines: Missing deadlines for RMDs or failing to empty the account by year 10 can result in significant penalties.
  • Evaluate Roth Conversion: If eligible, converting part of a traditional IRA to a Roth IRA could reduce tax burdens on future distributions.

The Legacy of the Stretch IRA

Before the SECURE Act, beneficiaries could use a “stretch IRA” strategy, withdrawing funds over their lifetime to maximize tax-deferred growth. The introduction of the 10-year rule largely eliminated this option, but EDBs can still take advantage of stretch provisions.
Spouses, in particular, continue to enjoy greater flexibility, making spousal inheritance one of the most advantageous scenarios for inherited IRAs.

Final Thoughts

Inherited IRAs provide an opportunity to preserve and grow wealth, but they come with strict rules. Understanding the 10-year rule, exceptions, and tax implications is critical for managing these accounts effectively.

Whether you’re navigating an inherited IRA as a spouse, non-spouse, or EDB, consulting a financial professional can ensure you comply with regulations and make decisions that align with your financial goals. By staying informed and planning strategically, you can honor the legacy of the original account holder while securing your financial future.

Contributed by Steven M. Roff

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