How can I avoid making costly mistakes when I inherit an IRA from a person who was not my spouse? Inheriting an IRA can be a financial windfall, but it’s important to understand the complex, specific rules that apply to non-spouse IRA beneficiaries to avoid critical errors.
Changes to the SECURE Act and 2024 IRS regulations have also transformed the rules for inherited IRAs, making proper planning essential.
Following these five important steps can help you navigate these complexities and maximize your inheritance:
1. First, Don't Do Anything!
When you learn you've inherited an IRA, resist the urge to take immediate action. Above all, don't take a distribution from the account without proper planning.
Taking distributions without understanding the rules may:
- Forfeit years of potential tax-favored investment returns
- Trigger unnecessary tax consequences
- Permanently limit your options
Inherited IRA funds are fundamentally different from your personal retirement accounts as they can't be:
- Combined with your other IRAs
- Contributed to (no additional deposits allowed)
- Converted to inherited Roth IRAs
- Rolled over through the 60-day rollover process (only direct trustee-to-trustee transfers are permitted)
Before making any moves, it can be beneficial to consult with a trusted financial advisorwho specializes in retirement accounts like our team at JL Smith. We can explain your options based on your specific situation and help you develop a strategy that aligns with your long-term financial goals.
2. Set Up a Properly Titled Inherited IRA
Once you've met with an advisor and developed a plan, the next step is setting up an inherited IRA with the correct title format. Your inherited IRA must be properly titled to maintain its tax-advantaged status.
If you prefer, you can move the funds to a different financial institution than where the original account was held. However, this transfer must be completed via a direct trustee-to-trustee transfer. As a non-spouse beneficiary, you cannot do a 60-day rollover; doing so would be considered a full distribution, potentially creating significant tax consequences.
3. Split Multiple-Beneficiary IRAs
If you're not the sole beneficiary of the inherited IRA, consider separating the account so each beneficiary obtains their own inherited IRA.
This step is crucial because:
- It helps ensure each beneficiary can follow distribution rules based on their own circumstances
- It gives each beneficiary control over their own investment choices
- It prevents one beneficiary's decisions from affecting others
- It allows each person to maximize their payout period under the rules
Splitting the IRA must be completed by December 31 of the year following the original owner's death, so don't delay addressing this important step.
4. Prepare for Required Minimum Distributions (RMDs)
Unlike your own retirement accounts, inherited IRAs - both traditional and Roth - are subject to required minimum distribution rules, often with accelerated timelines.
Important RMD rules for non-spouse beneficiaries:
- Under the SECURE Act of 2019, most non-spouse beneficiaries who inherit IRAs from individuals who died after December 31, 2019, must distribute all funds within 10 years
- Starting in 2025, if the original owner died on or after their Required Beginning Date (RBD), you'll also need to take annual RMDs during this 10-year period
- If the original owner died before their RBD, you can take distributions at any time during the 10-year period, if the account is emptied by year 10
- Strategic withdrawals during the 10-year period can minimize your overall tax burden compared to waiting until year 10
- Both traditional and Roth inherited IRAs are subject to distribution rules (though Roth distributions are generally tax-free)
Failure to take required distributions results in a significant penalty—up to 25% of the amount that should have been withdrawn—so proactive planning is essential.
5. Heed Deadlines and Maintain Records
Several critical deadlines apply to inherited IRAs:
- Inherited IRAs must be established and split by December 31 of the year following the original owner's death
- The first RMD may be required by December 31 of the year following the original owner's death
- All funds typically must be distributed within 10 years (with certain exceptions)
Additionally, check the records of the deceased IRA owner to determine if the account contained non-deductible contributions. These provide a basis in the account, allowing for tax-free distributions of these amounts, which can significantly benefit your withdrawal strategy.
Finally, don't forget to designate your own beneficiaries for the inherited IRA. While you can't extend the distribution timeline beyond what you've inherited, proper beneficiary designations help ensure your heirs can receive any remaining funds according to your wishes if you pass away before the account is fully distributed.
Securing Professional Guidance for Your Inherited IRA
The complex details of an inherited IRA can be overwhelming to sift through on your own. At JL Smith Holistic Wealth Management, our Bucket Plan Certified® advisors specialize in helping beneficiaries manage inherited retirement accounts while integrating them into a comprehensive holistic financial plan.
We understand the emotional and financial complexities that come with inherited assets. Our team will help you:
- Create a tax-efficient withdrawal strategy for your inherited IRA
- Integrate these assets into your existing financial picture
- Avoid common and costly mistakes
- Ensure all deadlines are met and requirements satisfied
Don't risk making expensive mistakes with your inherited IRA. Schedule a complimentary consultationtoday to see how our experienced advisors can help you make the most of your inheritance while honoring your loved one's legacy.
This material was developed and produced by Ed Slott and Company, LLC to provide information on a topic that may be of interest. Ed Slott and Company, LLC is not affiliated with The JL Smith Group or Prosperity Capital Advisors (PCA).