Prior to 2020, anyone who inherited an IRA could utilize an estate strategy known as a "stretch IRA" that involved naming younger beneficiaries (e.g., children, grandchildren, or great-grandchildren) rather than a spouse. In doing so, the account holder paved the way for wealth to pass on to future generations set to benefit from prolonged tax-deferred asset growth. Unfortunately, however, the enactment of the SECURE Act 1.0 in 2019 all but eliminated this option.

In this post, we'll outline inherited IRA ("beneficiary IRA") options under current laws (which apply to traditional, rollover, SEP, or SIMPLE IRAs unless otherwise noted).

Inherited IRA distribution rules: a broad overview

Unfortunately, most rules surrounding inherited IRAs aren’t straightforward and vary based on one's relationship with the deceased and the ages of both parties.

Generally, those who aren't an eligible designated beneficiary (EDB)—such as spouses, minor children, chronically ill or disabled individuals, or individuals who are not more than 10 years younger than the account owner—must adhere to the 10-year rule when inheriting an IRA.

The 10-year rule requires you withdraw funds from the inherited account within 10 years of the IRA owner's death. For example, if the IRA owner passes away in 2025, funds in the inherited IRA must be fully distributed by December 31, 2035 with the account then closed. Beneficiaries have the flexibility to take distributions of any amount and at any frequency during this 10-year period.

Inherited IRA rules for spouses

Spouses get the most leeway; if you’re the beneficiary of your spouse's IRA, you have several options when it comes to managing inherited assets including…

Taking a lump-sum withdrawal

In choosing the most straightforward option, you’d withdraw the entire balance at one time but would be subject to income taxes on this amount—with the transaction possibly bumping you into a higher tax bracket. As a result, you may end up paying more in taxes than you initially expected.

Rolling over assets into an IRA

A second option to consider—especially if your spouse was older when he/she passed away and you don’t have an immediate need for the money—is to roll over inherited assets into your own IRA (whether a new or existing account) per standard IRA rules.

In opting for this route, you can make pre-tax contributions to the account that will grow tax-deferred and have the ability to name your own beneficiary. You can also defer required minimum distributions (RMDs) until you turn 73 (RMDs are the minimum amount of money one must withdraw from specific tax-deferred retirement accounts beginning at age 73, climbing to age 75 in 2033). It’s important to know that if your spouse had already begun taking RMDs but not the required amount before passing, you'll need to go ahead and follow suit for the current year.

Transferring assets into an inherited IRA

Another option to consider is transferring the assets to an inherited IRA and naming yourself as the owner, often a good choice if you were older than your spouse upon their passing and under age 73 at that time.

The corresponding benefit is the ability to delay taking required minimum distributions (RMDs) until the year your spouse would have turned 73, a choice also beneficial for widows requiring access to funds and younger than age 59½ as they can avoid the 10% early withdrawal penalty that typically applies to retirement accounts.

One significant drawback, however, is that this type of IRA is not protected from creditors under federal bankruptcy law—dictating those not in a healthy financial situation tread carefully here.

Converting assets to a Roth IRA

A fourth choice is to convert inherited assets into a Roth IRA (a "Roth conversion"), a viable option for spouses who anticipate occupying a higher tax bracket in the future. It's important to keep in mind tax implications, however, as taxes will apply to the converted amount. A Roth conversion is also sometimes a beneficial choice for spouses seeking to avoid required minimum distributions (RMDs) and leave their heirs a tax-free inheritance.

Disclaiming the inheritance

One final option is to disclaim the inheritance, doing so (as required) within nine months of the original owner’s death and thus allowing the assets to pass to a contingency beneficiary, trust, or charity. This option, primarily utilized by those who don’t need the assets nor want the additional income due to potential estate tax consequences, is an irrevocable decision that cannot be reversed.

Inherited IRA rules for those not a spouse nor an eligible designated beneficiary (EDB)

Non-spouse IRA beneficiaries who are not classified as an eligible designated beneficiary have three options: they can either take a lump-sum payment, disclaim the proceeds, or establish a new inherited IRA.

Non-spouse beneficiaries who opt for a new inherited IRA must comply with the 10-year rule dictating they withdraw all funds from the account within 10 years of the IRA owner's death—with the new inherited IRA established by December 31 of the year following the same.

Additionally, if the original owner didn't take a required minimum distribution (RMD) and was required to do so, an RMD must be taken from the inherited account by December 31 of the year of the owner's death.

For inherited IRAs with multiple beneficiaries, meanwhile, all beneficiaries must transfer their respective shares into separate inherited IRAs by December 31 of the year following the owner's death—taking RMDs based on the life expectancy of the beneficiary with the shortest life span (i.e., the oldest beneficiary) beginning the year after the owner's death if they fail to establish separate accounts by the 12/31 deadline.

Inherited IRA rules for an eligible designated beneficiary (EDB) who is not a spouse

A non-spouse eligible designated beneficiary includes minor children of the original account holder, individuals who are chronically ill, those who are permanently disabled, and individuals no more than 10 years younger than the original account holder.

These beneficiaries have a few options for how to manage the inherited account: they can take a lump-sum distribution of the entire amount, make withdrawals based on their life expectancy, or follow the 10-year rule. If you fall into this category, here are some important points to know:

Minors aren't legally allowed to own property (meaning they cannot inherit an IRA directly), so most people designate a custodian—typically the minor's legal guardian—or a trust to manage the funds until the beneficiary reaches the age of majority.

Minor children designated as beneficiaries must then follow the 10-year rule upon reaching the age of majority, typically between 18 and 21 years old depending on the state of residence. An exception exists for minors who are children of the account owner, however, whereby they can withdraw from the inherited IRA with the 10-year rule applying to remaining funds when they reach the age of majority.

To be considered “disabled,” one must meet criteria defined in IRC Section 72(m)(7). With respect to a “chronically ill” designation, meanwhile, an individual must be unable to perform at least two of six activities of daily living (ADLs)—eating, toileting, transferring, bathing, dressing, or continence—for a period of 90 days.

Inherited IRAs: trusts, entities, & charities

If you inherited an IRA through a will/estate or are a charity or organization, the age of the original account owner determines how you distribute the assets.

If the original owner was under the age of 73, for example, you must completely distribute the assets by December 31st of the fifth year following the original owner's death (commonly referred to as the "5-year rule"). However, if the original owner fulfilled the required minimum distribution (RMD) age, you're generally required to take RMDs based on his/her life expectancy.

Finally, if the original owner did not take required minimum distributions (RMDs) and was obliged to, an RMD must be taken from the inherited account by December 31 of the year of his/her death.

Inherited Roth IRA rules

Withdrawal rules for inheriting a Roth IRA are quite similar to those for other types of IRAs. Spouses who inherit a Roth IRA, for example, have the same options at their disposal that mimic all other IRAs. An eligible designated beneficiary (who is a non-spouse) can choose to take a lump-sum distribution of the entire amount, withdraw funds based on his/her life expectancy, or follow the 10-year rule. For all other Roth IRA heirs, the 10-year rule applies.

Key Roth IRA distinctions are that withdrawals are tax-free and there's no need to worry about required minimum distributions (RMDs).

In summary: inherited IRA withdrawal rules

The laws regarding inherited IRAs became more complicated when the SECURE Act 1.0 was passed in December 2019 followed by the SECURE Act 2.0 in December 2022. Mistakes in handling these accounts are often very costly, so it's imperative to avoid any surprises come tax time and thus partner with a trusted financial advisor who can guide you through options unique to your own personal financial situation.

Still have questions about inherited IRAs? Schedule a FREE discovery call with one of our financial advisors to get them answered asap.

Inherited IRA Rules: Understand Your Options