Inherited an IRA? Now What? Understand Your Choices

If you’ve inherited an IRA, you may be trying to decide what to do with the money. Your choices vary depending on your relationship to the deceased IRA account owner. clearly: inherited IRA and investment options
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Key Takeaways

  • Decide how you want to use the inherited IRA assets: to build savings or help cover expenses
  • Make sure you have the funds to help pay any taxes on distributions
  • Work with a tax-planning professional who can help you pick the best option for your situation

Inheriting an IRA from a loved one is a reminder that they cared about you and your financial well-being. And when you’re ready, you’ll have to decide what to do with the assets. Your choices vary depending on whether you’re a surviving spouse or a non-spousal beneficiary such as another family member or friend.

Each option has its own potential benefits and considerations, and several factors may influence your decision, including the type of IRA (traditional or Roth), your age, the age of your loved one, potential taxes, and your financial situation.    

Here's a high-level overview to help you get started. You should also seek help from an estate attorney or tax professional.  

Surviving Spouse: Inherited IRA Rollover

If you’ve inherited an IRA from your spouse, you have an option that no one else has. “You can add the inherited IRA assets to your own IRA and potentially keep it growing, which may give you more money for retirement,” says Christine Russell, senior manager, retirement and annuities for TD Ameritrade. Keep in mind it has to be the same type of IRA you inherited. For example, if your spouse had a Roth IRA, you have to roll the money into a new or existing Roth IRA.

Rolling over the inherited assets to an IRA may help preserve any potential tax benefits, including the opportunity for tax-deferred (traditional) or tax-free (Roth) growth. Another reason to consider a rollover is that you may be able to make additional contributions to help build your savings.

And if you want tax-free income in retirement or think your tax rate may be higher in the future, you could consider converting your traditional IRA rollover to a Roth. Keep in mind that depending on the type of contributions your spouse made to their IRA, you'll have to pay taxes on the converted amount. Before converting, you might check your spouse's past tax returns to see if they included Form 8606, which is used to report non-deductible IRA contributions. Non-deductible contributions aren't taxable when you do a Roth conversion because any taxes have already been paid on the money.

Additional Options for Surviving Spouses

Surviving spouses who don't want to do an IRA rollover can choose one of the following three choices instead:

  • Move the assets to an inherited (beneficiary) IRA. With this option, the IRA account is re-registered as an "inherited" IRA in your name. Whether or not this option makes sense for you may depend on the type of IRA you've inherited (traditional or Roth) because of the possible taxation and the required minimum distribution rules. 
    • Traditional beneficiary IRA. Any distributions are generally taxable, but the 10% penalty for early withdrawals before age 59 1/2 doesn't apply. In addition, the timing of required minimum distributions (RMDs) is based on whether your spouse was under or over age 70 1/2 at the time of death. If your spouse was over age 70 1/2, you have to continue to receive the RMD payments. If your spouse was younger, you can postpone taking RMDs until the year they would have turned 70 1/2. There's also a 50% excess penalty for any missed RMDs. You might consider this option if you think you may need to take money out before age 59 1/2 or if you're older than your spouse and want the RMD start date to be based on their age and not yours, Please remember to consult a tax advisor about your specific circumstances. 
    • Roth beneficiary IRA. While the RMD rules are the same as a traditional benefciary IRA, withdrawals are generally tax-free if certain requirements are met. Given this, you might only consider this option if you expect to later roll the assets to your own Roth IRA or take all the money out before the RMD rules kick in.  
  • Take a lump sum distribution. If you have an immediate need for the money, you might decide to receive a lump sum distribution. Although you'd be giving up any tax benefits that you might get by keeping the money in an IRA like the potential for tax-deferred or tax-free growth. Plus, if it's a traditional IRA, you may have to pay taxes on the amount you receive, which could possibly push you into a higher tax bracket for that year.
  • Disclaim the inherited assets. You can also refuse all or some of the money. If you do, the inherited assets will pass to the next eligible beneficiary. So this option may be a way for you to help someone whose financial situation may not be as solid as yours. You could also potentially stretch out the IRA tax benefits to future generations if the other beneficiary is younger than you such as a child or grandchild. Note: The decision to disclaim assets must be made within nine months of your loved one's death.

Other Family Members and Friends 

With the exception of a rollover to your own IRA account (assuming the assets), other family members and friends have the same choices as the ones outlined above for surviving spouses. And the rules are essentially the same, but the timing for RMDs is slightly different; you generally have to start taking distributions by December 31 of the year after death.

Because beneficiaries who are other family members and friends generally have to begin receiving checks from the inherited IRA (and including the taxable amount in income), Russell says, “They may want to use this money to help cover their current monthly expenses, like rent or mortgage. This may free up some of their paycheck for savings—either in their work 401(k) plan, a personal IRA/Roth, or SEP IRA if they own a small business.” 

She goes on to say that inherited IRA assets could be an unexpected boon to your financial security. By naming you as their beneficiary, your loved one has given you a “gift” of assets that could help you pursue your goals and build your savings. But with this gift comes many choices and rules. So it’s important to give your decision some thought. Along with consulting a qualified tax advisor, a financial goal-planning session with a TD Ameritrade financial consultant may also be a good place to start in deciding  which inherited IRA option makes sense for your personal situation.  

TD Ameritrade does not provide tax advice. We suggest you consult with a tax-planning professional with regard to your personal circumstances.


Key Takeaways

  • Decide how you want to use the inherited IRA assets: to build savings or help cover expenses
  • Make sure you have the funds to help pay any taxes on distributions
  • Work with a tax-planning professional who can help you pick the best option for your situation

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