Being named the beneficiary of a person’s retirement plan is an honor and demonstrates that the person who passed away was willing to trust you with their life savings. However, if you are receiving this type of inheritance, you should know it also comes with significant responsibilities, choices, and potential consequences.
The laws governing inherited IRAs (individual retirement accounts), also known as beneficiary IRAs, are very complex — especially since the 2019 passage of the Setting Every Community Up for Retirement (SECURE) Act, which contained significant and far-reaching changes to IRAs, 401(k)s, RMDs, and more.
That means that handling an inherited IRA may be one of the biggest challenges you face concerning a deceased person’s estate, and the consequences can be costly at tax time.
This article will address some critical questions about inheriting an IRA and help you understand the pitfalls and decisions you may face as a beneficiary. Continue reading to discover more.
An inherited IRA is a particular type of retirement account you open when you inherit a tax-advantaged retirement plan, such as an IRA or employer-sponsored plan. This happens when the former owner of the plan passes away and has designated you the heir to their plan.
You can inherit anyone’s IRA. However, there are a few things to keep in mind if you receive one. Firstly, the rules differ depending on whether or not the original owner was your spouse. Additionally, becoming the beneficiary of an inherited IRA is not a simple process. Typically, you will be required to open up a new IRA account in your name and transfer the original owner’s assets from their account to yours.
What’s more, as with any other type of IRA, certain restrictions come with an inherited IRA. Depending on your circumstances and personal preferences, you may want to consider several factors before deciding whether to accept this kind of inheritance.
For example, you’ll need to make some choices to avoid accidentally violating IRS regulations, and there are specific errors and oversights you will need to be aware of unless you want to create delays or incur penalties. Furthermore, you may be able to take advantage of tax breaks and other opportunities to lower costs and avoid issues.
One of the most important things to point out right off the bat about an inherited IRA is that you may not be able to make any more contributions to the account after receiving it. Most beneficiaries can only take distributions and must do that according to precise rules.
For example, most beneficiaries have only ten years following the original owner’s death to liquidate the account of all funds due to a new rule imposed by the SECURE Act. There are several ways of complying with the ‘Ten-Year Rule,’ each with different tax ramifications.
There are also some exceptions to the rule, including:
More good news: If you are excepted from the ten-year rule, you can also make contributions and take distributions to the account just as if you’d opened it yourself. Essentially, suppose you fall into one of the above categories. In that case, you may be able to treat the assets as if they are your own, per the rules that govern that type of IRA (for example, you must follow the rules for a Traditional versus a Roth IRA).
Furthermore, if you are the surviving spouse, you can also choose to treat the IRA as your own by rolling it over into your IRA, or to the extent that it is taxable, into a:
You may also treat yourself as the beneficiary rather than treating the IRA as your own.
On the other hand, if you are not exempt from the ten-year rule, you still have choices when inheriting an IRA.
Suppose you do not wish to transfer the funds into your account. In that case, you can immediately take the inheritance in a lump sum — but consider that you could end up paying income taxes on the taxable portion of that sum, which in turn could move you into a higher tax bracket with higher rates.
On the subject of tax liability…
An IRA is a tax-advantaged retirement account. That means that contributions made to an IRA throughout the owner’s life are pre-tax, meaning that only withdrawals from the account are taxed.
Unfortunately, withdrawals may be taxed at your ordinary income tax rates if you are the beneficiary of a Traditional IRA. Roth IRAs, on the other hand, are typically funded with taxed contributions, meaning withdrawals are not subject to tax. You can even combine an inherited Roth IRA with another Roth IRA you maintain, provided you either:
There are some exceptions for Roth IRA beneficiaries. If you are the deceased’s spouse and decide to roll the IRA into your own, withdrawn earnings on the account will be taxable until you reach age 59 ½ and until a five-year holding period is complete. Similarly, if you take a lump sum distribution from a Roth IRA before the five-year holding period is complete, your withdrawal will also be taxable in those circumstances.
Beneficiaries of a Traditional IRA are also not without options for limiting their tax liability. For example, an inherited IRA is part of the deceased person’s estate. That means that the estate tax may apply in the case of larger estates (worth more than $12.06 million as of 2022). Here’s the good news for you as a beneficiary: You can take a deduction for any estate taxes paid on the account, even if the estate, and not you, had to pay the tax. Additionally, you may be able to delay paying taxes until the end of the ten-year period, and, of course, you can make strategic tax planning choices about the timing of your withdrawals.
As you may have gathered, the rules governing inherited IRAs are extraordinarily complex… even by IRS standards! Although this article has provided an overview of some options and considerations, there is more information on this subject we haven’t touched on.
For example, there are more rules that govern inherited Roth IRAs, you may encounter penalties for early withdrawals, and some distributions from Roth IRAs are not qualified, meaning they may add to your tax burden.
Ultimately, being the beneficiary of an inherited IRA is not the time to wing it — we strongly recommend seeking the advice and guidance of qualified financial professionals (like us).
If you are a client and would like to book a consultation, call us at +1 (212) 382-3939 or contact us here to set up a time.
If you aren’t a client, why not? We can take care of your accounting, bookkeeping, tax, and CFO needs so that you don’t have to worry about any of them. Interested? Contact us here to set up a no-obligation consultation.
Interested in receiving updates in your mailbox? Check out our newsletter, full of information you can use. It comes out once every two weeks, and you can register for it below.
Found this article helpful? Share it with your network.
Above & Beyond
New York City
2 West 45th Street, Suite 1208
New York, New York 10036
565 Taxter Road, Suite 105,
Elmsford, New York 10523
Jeff Coyle, CPA, Partner of Rosenberg Chesnov, has been with the firm since 2015. He joined the firm after 20 years of business and accounting experience where he learned the value of accurate reporting, using financial information as a basis for good business decisions and the importance of accounting for management.
He is a diligent financial professional, able to manage the details and turn them into relevant business leading information. He has a strong financial background in construction, technology, consulting services and risk management. He also knows what it takes to create organizations having built teams, grown companies and designed processes for financial analysis and reporting.
His business experience includes:
Creating and preparing financial reporting, budgeting and forecasting.
Planning and preparation of GAAP and other basis financial statements.
Providing insight on financial results and providing advice based on those results.
Jeff also has a long history of helping individuals manage their taxes and plan their finances including:
Income tax planning and strategy.
Filing quarterly and annual taxes.
General financial and planning advice.
Prior to joining the firm in 2015, Jeff was in the private sector where he held senior financial and management positions including Controller and Chief Financial Officer. He has experience across industries, including construction, technology and professional services which gives him a deep understanding of business.
Jeff graduated from Montclair State University, he is a CPA and member of the American Institute of Certified Public Accountants, New York State Society of Certified Public Accountants and New Jersey State Society of Public Accountants.
Jody H. Chesnov, CPA, Managing Partner of Rosenberg Chesnov, has been with the firm since 2004. After a career of public accounting and general management, Jody knows the value of good financials. Clarity, decision making, and strategy all start with the facts – Jody has been revealing the facts and turning them into good business results for more than three decades.
He takes a pragmatic approach to accounting, finance and business. His work has supported many companies on their path to growth, including helping them find investors, manage scaling and overcome hurdles. His experience and passion for business reach beyond accounting and he helps businesses focus on what the numbers mean organizationally, operationally and financially.
He has a particular expertise in early-stage growth companies. His strengths lie in cutting through the noise to come up with useful, out of the box, solutions that support clients in building their businesses and realizing their larger visions.
Prior to joining the firm in 2004, Jody was in the private sector where he held senior financial and management positions including General Manager, Chief Financial Officer and Controller. He has experience across industries, which gives him a deep understanding of business.
Jody graduated with a BBA in Accounting from Baruch College, he is a CPA and member of the American Institute of Certified Public Accountants and New York State Society of Certified Public Accountants.
In addition to delivering above and beyond accounting results, Jody is a member of the NYSCPA’s Emerging Tech Entrepreneurial Committee (ETEC), Private Equity and Venture Capital Committee and Family Office Committee.
He is an angel investor through the Westchester Angels, and has served as an advisor for many startup companies and as a mentor through the Founders Institute.
Send us a message and we will contact you as soon as possible.