Inheriting an IRA can provide meaningful financial support after the death of a family member, but beneficiaries should understand that inherited retirement accounts come with special federal tax and distribution rules.
The options available to you may depend on your relationship to the account owner, the type of IRA, the owner’s age at death, and when the owner died. A surviving spouse may have choices that are unavailable to an adult child or another beneficiary.
For Massachusetts residents, state income tax rules may also affect distributions. Reviewing these issues before withdrawing money can help you make informed decisions and avoid preventable tax or administrative problems.
What Changes When Inheriting an IRA?
An IRA generally passes according to the beneficiary designation on file with the financial institution. Because beneficiary designations can control retirement accounts separately from a will, keeping those forms current is an important part of estate planning.
The Law Offices of James A. Miller, P.C. discusses this issue further in its guidance on IRA inheritance planning and its year-end estate planning checklist.
Under current federal rules, beneficiaries generally fall into several categories:
- A surviving spouse
- An eligible designated beneficiary, such as certain disabled or chronically ill individuals
- A minor child of the deceased account owner
- A beneficiary who is no more than 10 years younger than the account owner
- Other individual beneficiaries, such as many adult children
- A Living Trust
These classifications matter because they can determine how long money may remain in the IRA and whether annual required minimum distributions, or RMDs, apply.
The IRS beneficiary guidance explains that the SECURE Act changed many inherited-account rules for deaths occurring after 2019. Many individual beneficiaries who do not qualify as eligible designated beneficiaries are now subject to a 10-year distribution period.
Spouses have additional choices. A surviving spouse may, depending on the circumstances, keep the account as an inherited IRA or treat the IRA as the spouse’s own. A non-spouse beneficiary generally cannot simply roll an inherited IRA into their own personal IRA.
Common Rules and Deadlines for Inheriting an IRA
One of the most important issues when inheriting an IRA is determining which distribution deadline applies.
For many non-spouse beneficiaries subject to the 10-year rule, the IRA must be fully distributed by December 31 of the year containing the tenth anniversary of the original owner’s death.
That does not necessarily mean every beneficiary can leave the entire balance untouched for nine years and withdraw it during year 10.
Current IRS rules distinguish between situations in which the IRA owner died before the owner’s required beginning date and situations in which the owner died on or after that date. If the owner died before the required beginning date and the 10-year rule applies, annual distributions generally are not required before the tenth year. Different requirements can apply if the owner died after RMDs had begun.
Beneficiaries should identify several dates and facts early:
- The IRA owner’s date of death
- Whether the owner had reached the applicable required beginning date
- The deadline for completing any required year-of-death distribution
- Whether annual beneficiary RMDs are required
- The final date by which the inherited account must be emptied
Inherited IRA rules depend heavily on individual facts. Beneficiaries should confirm the applicable schedule before acting.
Taking action early can also help prevent administrative errors. The beneficiary may need to provide a death certificate, establish an inherited IRA with the custodian, confirm how the account is titled, and obtain information about prior distributions.
Tax Issues to Consider After Inheriting an IRA
Federal income taxes are another major consideration. Taxable distributions from a traditional inherited IRA are generally included in the beneficiary’s gross income.
A large withdrawal may therefore increase taxable income for that year. In some situations, spreading permitted distributions across several years may produce a different tax result than withdrawing the entire account at once.
Before choosing a distribution schedule, consider questions such as:
- Is the account a traditional IRA or Roth IRA?
- How much of a distribution will be federally taxable?
- Could a large distribution affect the beneficiary’s income-tax bracket?
- Are annual RMDs required during the 10-year period?
- How will Massachusetts treat the distribution?
Massachusetts tax treatment deserves separate attention. The Commonwealth generally taxes traditional IRA distributions, but amounts representing contributions that were previously taxed by Massachusetts may receive different treatment. The state and federal taxable amounts can therefore differ. Mass.gov provides additional information through its guidance on the tax treatment of IRAs and other non-government retirement plans.
Beneficiaries should retain account statements, tax forms, and any records showing previously taxed contributions. A tax professional can help determine how federal and Massachusetts rules apply to a particular inherited account.
Common Mistakes and Next Steps for Inheriting an IRA
Many inherited IRA problems begin with decisions made before the beneficiary fully understands the account.
Common mistakes include:
- Taking an immediate lump-sum distribution without reviewing the tax consequences
- Assuming every beneficiary has the same 10-year distribution requirements
- Missing an RMD that applies during the 10-year period
- Moving inherited funds into an account that is titled incorrectly
- Assuming instructions in a will automatically control an IRA beneficiary designation
- Failing to coordinate the inherited IRA with the beneficiary’s broader estate and financial plan
Beneficiary designations should also be reviewed during a person’s lifetime. Marriage, divorce, births, deaths, and other changes can leave older beneficiary forms inconsistent with the rest of an estate plan. The firm’s resource on outdated estate planning documents explains why beneficiary forms deserve periodic review.
For someone already inheriting an IRA, the first step is usually gathering information rather than immediately withdrawing funds. Confirm the account type, beneficiary status, owner’s date of death, prior RMD history, and custodian requirements. Legal and tax professionals can then help identify which rules may apply.
Inheriting an IRA involves more than receiving an account balance. Federal distribution deadlines, beneficiary classifications, tax treatment, and Massachusetts rules can affect what happens next. Understanding those issues before making withdrawals can help a beneficiary make decisions based on the applicable rules and personal financial circumstances.
Getting Help from an Estate Planning Attorney
The Law Offices of James A. Miller, P.C. can provide the guidance and support you need when handling estate planning matters involving inherited retirement accounts, beneficiary designations, and long-term planning decisions. Our legal team can help you understand how an inherited IRA may fit into your overall estate plan and address important issues that may affect your loved ones.
Contact our Worcester estate planning lawyers today at (508) 799-8885 or reach out online to schedule a consultation and learn more about the assistance we can offer as you create your estate plan so you can avoid these and other common probate problems that are likely to arise.