How do inherited IRAs work in the post-SECURE Act world? Manager of Financial Planning Andrew Busa carefully explains the “need to knows” going forward plus a recent development just last week. Watch now.

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For informational purposes only. Not intended as investment advice.

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Individual Retirement Accounts (IRAs) have become a significant tool for retirement savings, allowing individuals to invest in various securities while receiving tax benefits. An inherited IRA, as the name suggests, is an IRA account that someone inherits from a deceased loved one. This often occurs between spouses or family members, but it can also apply to unrelated beneficiaries who are named in the account.

Inherited IRAs can be tricky and confusing, so it’s important to understand the basics before deciding to inherit one. Here are some things you should know about inherited IRAs.

1. Types of Inherited IRAs

There are two types of inherited IRAs: the traditional inherited IRA and the Roth inherited IRA. The traditional inherited IRA operates similarly to a traditional IRA, where the beneficiary takes required minimum distributions (RMDs) each year, based on their life expectancy, and pays taxes on the distributions as ordinary income. The Roth inherited IRA, on the other hand, is tax-free, and the beneficiary can take distributions without owing taxes. However, RMDs are still required.

2. Who Can Inherit an IRA

Spouses are the most common beneficiaries of an IRA. After the account owner dies, the surviving spouse can become the owner of the IRA and rollover the funds into their name. Non-spouse beneficiaries, such as children, siblings, or friends, can also inherit an IRA but cannot rollover the funds into their name. Instead, they must establish an inherited IRA account.

3. Timing for RMDs

The IRS requires that beneficiaries start taking distributions from the inherited IRA by December 31st of the year after the account owner’s death. The RMDs are based on the beneficiary’s life expectancy and can be taken in a lump sum, annually, or in any other way that is most beneficial to the beneficiary.

4. Tax Implications

Inherited IRAs have different tax implications than traditional or Roth IRAs. Traditional inherited IRAs are subject to ordinary income taxes on distributions, while Roth inherited IRAs are tax-free. Beneficiaries should consult with a tax advisor to understand the tax implications of their inherited IRA.

5. Stretch IRA

The “Stretch IRA” is a tax-minimizing strategy that allows beneficiaries to spread out the RMDs over their lifetime, effectively “stretching” the IRA’s tax-deferred growth for years. This approach can help maximize the account’s value and minimize the impact of taxes.

In conclusion, inherited IRAs can be a valuable source of retirement income for beneficiaries. However, it is essential to understand the rules and regulations governing these accounts to maximize their benefits. Consulting with a financial advisor or tax professional can help beneficiaries determine the best course of action to ensure they’re making the most of their inherited IRA.