Inherited Individual Retirement Accounts (IRAs) are opened when someone inherits an IRA or employer sponsored account after the original account holder’s death. Though you can inherit an account from anyone, be it a spouse or not, the rules for these accounts differ depending on your relationship with the deceased. In addition, regulations on these accounts have become more complicated after the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 and the SECURE 2.0 Act of 2022 were enacted. [1],[2]
How are these accounts distributed?
The assets from a deceased person’s IRA, whether a Traditional, Rollover, SEP, and/or SIMPLE IRA, will be transferred to the beneficiary to distribute the funds. 1
The beneficiary’s distribution options from the inherited account depend on whether they are Eligible Designated Beneficiary, Designated Beneficiary, or Non-Designated Beneficiary
These designations are based on the following: [2],[3]
Eligible Designated Beneficiary
is someone listed as the beneficiary on the original account and is the deceased’s legal spouse, a minor child of the deceased, a chronically ill or disabled beneficiary, or an inheritor less than ten years younger than the original owner of the account. 2,3
Designated Beneficiary
is someone listed as the beneficiary on the original account but has none of the other relationships, age, or health concerns of an Eligible Designated Beneficiary.2,3
Non-Designated Beneficiary
is someone listed in a will or a trust. But they are not listed as beneficiaries on the original account. These heirs will have to consult the executor of the will or the trustee of the trust to determine how to distribute funds from these accounts. 2
Eligible Designated Beneficiary
The solitary beneficiary spouse can:
Designated Beneficiary
Eligible Designated Beneficiary and Designated Beneficiary can:
Other Key Aspects of Inherited IRAs:
- If the original owner’s death was on or after 01/01/2020, the beneficiary rules in the SECURE Act would affect the inheritor’s distribution options as an Eligible Designated Beneficiary or Designated Beneficiary. Any death before this date would be able to follow the stretch rules that were allowed before. 6
- Beneficiaries of IRAs inherited in 2020, 2021, 2022, or 2023 should plan on receiving distributions from that IRA or qualified plan in 2024. The proposed regulations distributions are still in the works and have not yet been finalized. However, the IRS has waived penalties on missed distributions for 2023. It’s been announced that final guidance regarding the regulations will not be issued until 2024. *12, 13
- Though Inherited IRAs have vastly different distribution rules than other investment accounts, they are still investment accounts. And with all investment accounts, you expose some or all your invested money to loss for the chance to earn a higher profit. Investment gains hinge on an ongoing and long-term investment strategy that uses your risk tolerance and diversification to mitigate some risks. Even with these in place, you are exposing your money to loss.[14]
- Investment options within these accounts are almost anything- individual stocks, mutual funds, ETFs, annuities, UITs, etc. There are investment vehicles that are not allowed in IRAs, including Life Insurance, types of Derivatives Positions, antiques/collectibles, personal real estate, and most coins. [15]
- Fees vary from institution to institution. It is crucial to understand how much you are paying in fees.
- Investment control is either by your chosen institution or advisor or can be self-directed. With this type of account, you must know your risk tolerance and diversification strategy. These are especially important if you are self-directed and need to make changes to your investments as you make changes to your life and risk tolerance.[16]
If you want to explore additional retirement investment accounts that could work for your goals, Scarlet Oak Financial Services can be reached at 800.871.1219, or you can contact us here. To sign up for our weekly newsletter with the latest economic news, click here.
Sources:
[1] https://www.investopedia.com/terms/i/inherited_ira.asp
2] https://www.irs.gov/pub/irs-drop/n-23-54.pdf
3] https://www.schwab.com/resource/lets-talk-about-the-retirement-account-you-inherited
4] https://www.investopedia.com/articles/personal-finance/102815/rules-rmds-ira-beneficiaries.asp
5] https://www.marketwatch.com/story/who-is-exempt-from-the-10-year-rule-when-inheriting-an-ira-11620952971
6] https://www.irs.gov/publications/p590b#en_US_2020_publink1000230539
7] https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-beneficiary
8] https://eresourcecenter.ascensus.com/idcpro/groups/public/@resourcecenter/documents/webcontent/T014412.pdf
9] https://www.investopedia.com/articles/personal-finance/102815/rules-rmds-ira-beneficiaries.asp
10] https://www.investopedia.com/ask/answers/09/stretch-ira.asp
11] https://www.investopedia.com/articles/retirement/03/041603.asp#reasons-for-disclaiming-inherited-assets
12] https://taxschool.illinois.edu/post/navigating-the-new-regulations-for-inherited-iras/
13] https://www.forbes.com/sites/kristinmckenna/2023/07/19/beneficiaries-of-inherited-iras-get-more-rmd-relief—for-now/?sh=6d758d043266
14] https://www.investor.gov/sites/investorgov/files/2019-02/Saving-and-Investing.pdf
15] https://www.investopedia.com/articles/retirement/11/impermissable-retirement-investments.asp
16] https://www.nerdwallet.com/article/investing/ira/what-is-a-traditional-ira
This material has been prepared for informational purposes. *To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on individual circumstances.