Inheriting an Inherited IRA: What You Need to Know

Inheriting an individual retirement account (IRA) involves distribution rules and tax considerations. These rules become more complex when the account has already been inherited once, known as a successor inheritance. Whether you’re a spouse, child, or other beneficiary, understanding the rules helps you manage timelines and avoid unintended tax consequences.

A financial advisor can help interpret the rules surrounding your inheritance, whether it involves an IRA or other assets.

How an Inherited IRA Works

An inherited IRA is one that has been left to a beneficiary following the death of the original account holder. The beneficiary can then potentially pass this on to a successor beneficiary upon his or her death. This creates the scenario of inheriting an inherited IRA. 

You should first understand the difference between an original beneficiary and a successor beneficiary. If the account holder sets up the line of succession incorrectly the assets may need to go through probate. This means a judge can determine the rightful new owner. 

The original beneficiary is the first person to receive the IRA after the original account holder’s death. After inheriting the IRA, the original beneficiary can designate someone else to receive the account upon their death. That person becomes known as the successor beneficiary.

It’s important to remember that each beneficiary must follow specific distribution rules. Those rules can differ depending on whether the beneficiary is a spouse, non-spouse or a successor. Successor beneficiaries typically must continue the distribution schedule already in place. They do not receive a new 10-year window unless the original beneficiary was using the life expectancy method.

How the SECURE Act and SECURE 2.0 Changed the Rules

The SECURE Act, enacted in late 2019, significantly changed the distribution rules surrounding inherited IRAs, particularly those regarding the timeline for withdrawals. The law effectively did away with the “stretch IRA.” This strategy enabled beneficiaries to extend distributions, and defer taxes, over many decades.

Under the SECURE Act, most non-spouse heirs must now deplete the inherited account within 10 years. ¹ This change carries tax consequences, especially for beneficiaries who earn a high income.

If the original account holder started taking RMDs before their death, most non-spouse beneficiaries must take annual RMDs in years one through nine and fully deplete the account by year 10. These annual RMDs are set to become mandatory starting in 2025, according to IRS guidance under the SECURE 2.0 Act.

Successor beneficiaries must follow the same 10-year window established by the original beneficiary. An exception exists if the original beneficiary qualified as an “eligible designated beneficiary” (EDB) and used a life expectancy distribution schedule.

Here are the individuals who qualify as EDBs under the SECURE Act:

• Surviving spouse of the account holder
• Minor child of the account holder (only until they reach age 21; afterward, the 10-year rule applies)
• Disabled individuals
• Chronically ill individuals
• Individuals not more than 10 years younger than the deceased account holder

Preparing to Inherit an Inherited IRA

Inheriting an inherited IRA can involve complex tax rules and potential pitfalls. Understanding the rules and tax implications is key to maximizing the inherited assets and avoid unnecessary tax burdens. You could inadvertently trigger a taxable event by not taking the required distributions within the stipulated timeline, for example. 

The best way to prepare for inheriting any IRA is to understand your obligations and the rules surrounding the assets. If it’s a retirement account, like an IRA, then you’ll want to know what you need to do once you inherit the assets. That can help you properly plan your finances to account for those assets. 

Second, you’ll want to make sure that you have proper documention for the inheritance to help avoid probate. The last thing you want to do is to unexpectedly not receive assets you had been planning to inherit. It’s important to confirm that you’re properly listed as the successor. 

You’ll also need to determine whether the 10-year distribution period has already begun. Successor beneficiaries usually do not receive a reset of that timeline.

Tips for Inheriting an IRA

Inheriting an IRA involves a unique set of distribution rules, tax considerations, and strategic options. These all depend on your relationship to the original account holder. Here are some key points to consider:

• Spousal options: A surviving spouse can treat the inherited IRA as their own. This allows them to delay required minimum distributions (RMDs) and potentially reduce taxable income in the near term. Alternatively, they can remain a beneficiary and take distributions based on their own life expectancy or that of the deceased account holder.
• Year-of-death RMDs: If the original account holder was subject to RMDs and had not yet taken their required withdrawal for the year, the beneficiary may need to take that distribution before year-end to avoid penalties (25% of missed RMD; 10% if corrected within two years).
• Income tax deduction for estate taxes: Non-spouse beneficiaries may be able to deduct estate tax previously paid on inherited IRA assets when calculating income tax on distributions. This is known as the “income in respect of a decedent” (IRD) deduction.
• Inherited Roth IRAs: Roth IRAs are also subject to the 10-year rule if inherited by a non-spouse. However, distributions are typically tax-free, provided the account has met the five-year holding requirement.
• Professional guidance: Because tax implications can vary based on account type, beneficiary status, and timing, consulting a qualified tax advisor may help avoid missteps and identify potential planning opportunities.

How to Manage the Tax Impact of Required Distributions

The IRS taxes distributions from an inherited IRA as ordinary income, which means the timing of those withdrawals can have a significant impact on your tax bill. A large distribution may push you into a higher tax bracket, increase Medicare premiums or affect eligibility for certain income-based tax breaks and benefits.

One of the biggest mistakes beneficiaries make is delaying withdrawals until the final year of the 10-year window. Taking the entire balance at once can create a large spike in taxable income. Spreading distributions across multiple years may help smooth out the tax impact and keep more of the money in lower tax brackets.

Timing can matter just as much as the amount withdrawn. Years with unusually low income may create opportunities to take larger distributions at a lower tax cost. For example, someone between jobs, recently retired or experiencing a temporary drop in income may have more room to absorb inherited IRA income without moving into a higher bracket.

Deductions can also influence withdrawal decisions. If you expect significant medical expenses, large charitable donations or other deductions in a particular year, taking a larger distribution during that same period may help offset some of the additional taxable income.

The strategy is different for inherited Roth IRAs. Qualified Roth distributions are generally tax-free, so there is less concern about managing tax brackets. In many cases, beneficiaries may benefit from allowing the account to continue growing tax-free for as long as the distribution rules permit before withdrawing the funds.

Because inherited IRA rules can be complex, it often makes sense to look beyond the current year and evaluate the entire distribution period. A withdrawal strategy that considers future income, expected deductions and upcoming life changes may reduce taxes over time and help preserve more of the inherited assets.

Bottom Line

Inheriting an inherited IRA involves a complex process filled with numerous rules and potential tax implications. Staying informed and prepared can better equip you to navigate the complexities of inheriting an IRA. Through careful review of your timeline, distribution obligations and beneficiary status, you can preserve more of the account’s value and avoid unexpected tax consequences.

Tips for Estate Planning

• In order to make sure you’re either correctly listed as a beneficiary to certain assets, or you want to solidify your own estate plan, a financial advisor can help. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• When going about creating your estate plan, consider using SmartAsset’s free estate planning checklist to make sure you’ve covered everything that’s needed. 

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