Inheriting IRAs from someone that isn’t your spouse

If you are the daughter, son, sister, brother, or even a close friend of an IRA owner who has named you as their beneficiary, it’s very important that you and the owner of the IRA understand the rules that govern IRA inheritances.

Here is what you need to know about inheriting IRA assets as a nonspouse beneficiary. The rules for inheriting IRA assets depend on your relationship to the original IRA owner and the type of IRA inherited. A discussion in advance with your tax advisor or attorney may help you avoid any unintended consequences.

The IRS typically requires non spouse inherited IRA owners to take required minimum distributions no later than December 31 in the year following the death of the original account owner. Distributions taken from inherited IRAs are not subject to a 10% early withdrawal penalty in most cases.

With the passage of the SECURE act, IRA distribution to a nonspouse must be done within 10 years following the death of the account owner. Previously, if you inherited a 401(k) or IRA, you could possibly “stretch” your distributions and tax payments over your life expectancy. The SECURE act has removed this “stretch” provision for certain beneficiaries.

1. Transfer the assets to an inherited IRA and take RMDs


When a traditional IRA is transferred into an inherited IRA, sometimes also referred to as a beneficiary distribution account, there are RMD rules to obey, which are set by the IRS. Your options for taking distributions from the IRA are based off of when the original owner died.

If the owner died before December 31, 2019 and 

  • Died before reaching age 70 ½ 

You can start taking RMDs no later than December 31 of the year following death. You also have an option to distribute your inherited IRA under the 5-year rule. This lets you take distributions however you like without penalty, as long as all of the assets are completely distributed from your inherited IRA by December 31 of the 5th year following the IRA owner’s death. You need to discuss with your tax advisor about the potential tax implications of this accelerated withdrawal schedule. 

  • Died after reaching age 70 ½ 

You may elect to calculate those RMDs by using your own age or by using the original IRA owner’s age in their year of death, whichever longer. This can be advantageous if the original IRA owner was younger than you. In this case of a nonspouse inheritor, RMDs are typically required to begin in the year after the year of death..

If the original IRA owner died on or after January 1, 2020

The SECURE Act requires beneficiaries to withdraw all assets from an inherited IRA or 401(k) plan by December 31 of the 10th year following the IRA owner’s death. Some exceptions to the 10-year rule include payments made to an eligible designated beneficiary (minor child of account owner, surviving spouse, disabled 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 of their life expectancy. You should discuss potential tax implications and distribution options of this accelerated withdrawal schedule with your tax advisor.

If you’re listed as a nonspouse beneficiary along with one or more other beneficiaries

It’s important to separate your portion of the descendants IRA in your name then complete your first RMD by December 31 of the year following the original IRA owner’s death. If you don’t get to this deadline in time, your RMD calculation will be based off of the oldest beneficiary’s life expectancy. If that person is older than you are, you will need to take a larger distribution.

If you inherit a Roth IRA that was funded for 5 years or more prior to the death of the original owner, distributions can be taken tax-free. Talk with a tax advisor if you’ve inherited a Roth IRA that wasn’t funded for 5 years before the original owner passed away.

If you don’t have an immediate need for the money, leaving the assets in the inherited IRA may be the smartest thing to do over the long term. This is because the longer you keep the money in there, the longer you will be happy with potential tax-deferred growth, or, in the case of an inherited IRA, potential tax-free growth. When you take money out of an inherited IRA, it will probably be taxed as ordinary income. The more you withdraw from an inherited IRA now, the less you will have to build on for the future.

2. Disclaim (decline to inherit) part or all of the assets


If you decline to accept part or all of the IRA assets that you’re entitled to, they will pass to the other eligible beneficiaries. If there aren’t any other beneficiaries, the assets will pass in accordance with the IRA provider’s custodial agreement. 

Important things to remember:

Determine whether you are listed as someone’s beneficiary

It may be a sensitive topic to broach with loved ones, knowing in advance can be very helpful. As life events such as divorce, marriage, and death occur, it’s in your best interest to confirm that beneficiary designations are up to date. 

Commingling of inherited IRAs

If you inherit IRAs from different owners, you cannot combine them into one inherited IRA. As for commingling IRAs of the same account type, their answer differs when they were inherited from the same original owner, which is allowed. Consult a tax advisor on your situation.

Request a trustee-to-trustee transfer

You need to make sure that any assets transfer directly from one account to another or from one IRA custodian to another. There isn’t an option for a 60-day rollover when a non-spouse beneficiary is inheriting IRA assets. If you receive a check, the money will generally be taxed as ordinary income, and will be ineligible to deposit into an inherited IRA you may own or another firm, or back into the inherited IRA that it was withdrawn from to begin with.

Distributions from an inherited IRA can be invested in other accounts

Consider all your options when taking RMDs and other distributions from an inherited IRA. Typically, your distribution is included in your gross income and will be subject to ordinary state and federal income taxes. Once funds are distributed from an inherited IRA, the money becomes yours.

Non-spouse beneficiaries do not have bankruptcy protection with inherited IRAs

In 2005, the US Supreme Court ruled that an inherited IRA held by a nonspouse beneficiary is not exempt from attachment by creditors under the Bankruptcy Abuse Prevention and Consumer Protection act of 2005. While some states have laws that still protect inherited IRAs, for a nonspouse beneficiary living in a state without such laws, the inherited IRA is effectively now treated as any other account owned by the beneficiary for bankruptcy purposes, and may not be protected under bankruptcy from claims by creditors. It’s not clear how this decision affects an inherited IRA held by a spousal beneficiary. Beneficiaries should speak with their attorney or tax advisor before taking any distribution from a retirement account or if they have any questions regarding protection from creditors.