Many people think they can roll an inherited IRA into their own IRA. However, if you inherited an IRA from someone who is not your spouse, you can’t roll the account into your own IRA or treat it as your own.
Cash in the IRA Within 10 Years
You always have the option of cashing in an inherited IRA. You will pay taxes on the amount of the distribution but no 10% IRA early-withdrawal penalty tax. If you choose this option, you must cash in the entire inherited IRA by December 31 of the 10th year following the original IRA owner’s death. Although no penalty tax applies, this may not be your best option. Cashing in a large IRA could mean that up to 37% of it would go right to federal taxes. State income taxes will apply, too.
Exceptions To the 10-Year Rule
Exceptions to the 10-year rule include payments made to an eligible designated beneficiary: a surviving spouse, a minor child of the account owner, a disabled or chronically ill beneficiary, and a beneficiary who is not more than 10 years younger than the original IRA owner or 401(k) participant. These beneficiaries can “stretch” payments over their life expectancy.
Stretch IRAs for Deaths Before 2020
As a beneficiary, you must take minimum distribution amounts from the inherited IRA each year, according to your life expectancy, using a specific set of rules. These distributions are called required minimum distributions (RMDs).
Using Stretch IRAs
Prior to the 2019 SECURE Act, you were able to set up an inherited IRA, with you as the beneficiary, and take RMD withdrawals slowly. This option of taking withdrawals over your life expectancy was frequently referred to as a “stretch IRA.” The nice thing about this option was that you could always withdraw the money sooner if needed. The RMD rules simply dictated the minimum you must withdraw. Withdrawing more than the minimum was always allowed. If you are the recipient of a stretch IRA, your first required minimum distribution must occur by December 31 of the year following the year of the original IRA owner’s death. You need the following information to calculate the required minimum distribution amount:
Your age as of December 31 of the year following the original IRA owner’s deathThe account balance as of December 31 of the prior year
Use the information above in the steps outlined below: If the original IRA owner died before Dec. 31, 2019, the stretch IRA option is available. If the original IRA owner died on or after Jan. 1, 2020, then the IRA falls under the SECURE Act’s rules. That means non-spousal beneficiaries must withdraw all assets from an inherited IRA or 401(k) plan by December 31 of the 10th year following the IRA owner’s death.
When Trusts or Other Entities Inherit the IRA
If you represent a trust or other entity that is not an individual person, a different set of rules will apply. You can cash in the IRA, and you will likely have to do so within five years (not 10). However, when the trust’s beneficiaries are individuals, those individuals will be treated as designated IRA beneficiaries to determine RMDs. If you aren’t careful, you may pay more in taxes than you should. Cashing out triggers income taxes, and missing RMDs could trigger excise taxes as high as 50%. If the IRA is sizable, talk to a financial planner before doing anything. Remember, you will have years to take action. There is no need to rush the decision and create taxable events.
Set a Designated Beneficiary for Your IRA
IRA beneficiaries supersede a will or trust. Make sure your beneficiary designations are up to date on your IRAs. If appropriate, ask family members whether you are identified as a beneficiary on their accounts. Having that information can be helpful when they pass away.
