Inherited IRA: Rules and Tax Doubts Explained for Spouses and Non-Spouses

Grieving the loss of a loved one is a complicated, difficult time that can be interrupted by the bureaucratic processes of an inherited IRA. If you're inheriting an IRA, understanding the rules and options available is crucial to making informed financial decisions. 

In this article, we partner with experts to break down everything you need to know about inherited IRAs, including the specific rules for spouses and non-spouses, your options, and common questions about this complex matter. 

What is an inherited IRA (IRA BDA)?

Let's start with a bit of a glossary:

• A traditional IRA is a tax-advantaged personal savings plan where contributions may be tax-deductible. Upon withdrawal of funds, the money is taxed. 

• A Roth IRA is an individual retirement account that isn't taxed upon distribution if certain conditions are met.

An inherited IRA, also known as a Beneficiary Distribution Account (IRA BDA), is an account opened when someone, who can be a spouse or non-spouse like a child or other family member, for example, inherits an IRA from a deceased account holder. That inherited IRA may be either a traditional IRA or a Roth IRA.

Inherit IRA rules: Understand your options

When you inherit an IRA, you take ownership of the funds in the account. “IRA rules are governed by federal law and are the same in all 50 states,” says  Loretta Kilday, a senior attorney from Debt Consolidation Care.

However, you are subject to certain distribution rules. These rules depend on whether the original account was a traditional IRA or a Roth IRA and whether you, as a beneficiary, are a spouse or a non-spouse. 

For example, if you’re inheriting an IRA as a non-spouse, you might be subject to the 10-year rule, which requires you to distribute all funds from the inherited IRA account within 10 years. As a spouse, you have more flexibility with the option to treat the inherited IRA account as your own. 

Inherited IRA: Rules for spouses

A spouse is considered an eligible designated beneficiary and has the most options for flexibility within the account. “If you inherited and are a spouse, that’s the best position you can be in,” says financial planner Reagan Smith, of Millennial Wealth. 

Here are your options:

• Treat it as your own: If you're a spouse inheriting an IRA, you can treat the IRA as your own. This means you can roll the inherited IRA into your existing IRA, or designate yourself as the owner of the inherited IRA account. 

• Let it stand as an inherited IRA: You can keep the IRA as an inherited IRA, which means you follow the distribution rules of the original account holder. 

• Take required minimum distributions (RMDs): If you choose to treat the IRA as your own, RMDs will be based on your age. However, if you keep it as an inherited IRA, you may need to start taking RMDs based on the original account holder's age.

Inherited IRA: Rules for non-spouses

Non-spouses include children, siblings, friends, or anyone who is not the spouse of the deceased person. Here are the inherited IRA rules for non-spouses: 

• 10-year rule: Most non-spouse beneficiaries must distribute the entire account—whether IRA or Roth IRA—within 10 years of the original account holder's passing. With a Roth IRA, you won't owe taxes on the withdrawals as long as the account has been open for at least five years. 

• Inherited IRA RMD rules: If the original account holder was already taking RMDs, you must continue taking them based on their schedule until the account is fully distributed within ten years.

Smith also highlights a few specific cases for non-spouses that may make them exempt from the rules above if they are:: 

• Not more than 10 years younger than the deceased 

• A minor child of the deceased (under 21 years or if you are a full-time student under 26 years)

• Disabled (unable to engage in substantial gainful activity due to physical or mental disability that will most likely lead to premature death, with proof from a doctor) 

• Chronically ill (suffering to perform 2 ADLs)

How is an inherited IRA split between siblings?

If multiple beneficiaries are named, the IRA can be split into separate inherited IRAs for each beneficiary. This allows each sibling to manage their portion individually, following the respective RMD rules.

What happens if you inherit an IRA?

Processing your grief while inheriting an IRA can be overwhelming. We are breaking down step-by-step what happens if you inherit an IRA to guide you in this detailed process.

1. Consult a financial advisor: Don't pressure yourself to understand it all on your own. Professional advice will help you navigate the complexities and tax implications that come with inheriting an IRA. 

2. Understand the rules: Familiarize yourself with the inherited IRA distribution rules and RMD rules for your situation.

3. Choose the best option: Decide whether to treat the IRA as your own, open an inherited IRA, or take a lump-sum distribution, depending on the scenario that best matches your situation.

Is there a way to calculate inherited IRA distribution?

Receiving an inherited IRA can drastically impact your finances, so you might be interested in calculating the amount you're receiving to plan accordingly. 

To calculate your inherited IRA distribution, you’ll need to use the IRS's life expectancy tables. You can find different tables for various scenarios on the official IRS website. This calculation determines your RMDs, ensuring you follow the required minimum distribution inherited IRA rules. 

What are the taxes on inherited IRA distributions?

Inherited traditional IRAs are subject to income tax on distributions. The exception is qualified distributions from inherited Roth IRAs. It's important to plan for these taxes and consider their impact on your financial situation.

Whether you’re dealing with taxes on inherited IRAs or navigating the nuances of IRA BDA accounts, professional advice can make a significant difference.

Tax-free distributions from inherited Roth IRAs

Qualified distributions from inherited Roth IRAs are tax-free if the original Roth IRA owner has held the account for at least five years. 

So, if you inherit a Roth IRA and it meets the five-year holding period, you can withdraw the funds tax-free. If the five-year rule is not met, the earnings portion of the distribution will be taxed.

Can I withdraw all the money from an inherited IRA?

Yes, you can withdraw all the money from an inherited IRA, but doing so may have significant tax implications. “Withdrawals from a traditional inherited IRA are penalty-free but not income tax-free because the income has been tax-deferred,” Smith says.

It's crucial to understand the tax consequences before making a lump-sum withdrawal:

• Income tax: Distributions from an inherited traditional IRA are taxed as ordinary income. The amount withdrawn is added to your taxable income for the year, which could push you into a higher tax bracket. 

• Required Minimum Distributions (RMDs): Non-spouse beneficiaries must take RMDs based on their life expectancy or withdraw the entire account balance within ten years. Failing to take RMDs results in a 50% excise tax on the amount that should have been withdrawn. 

• Tax-deferred growth loss: By taking larger distributions, you may lose the benefit of tax-deferred growth, which can impact your long-term financial planning.

Understanding these tax implications will help you make more informed decisions about how to manage your inherited IRA, but we advise looking for a financial advisor to cruise over all these details and optimize your tax strategy.

Take the time to educate yourself, consult with a financial advisor, and choose the best path forward.