Losing someone you care about, and that cared about you, is never easy. If you are reading this, you may have also learned that you inherited their IRA from their estate. Over the past few years many of our clients have come to experience this. It can be confusing to know how and when to take distributions, as well as the tax consequences.
Do you take the full draw in year one, spread it out evenly, or wait until you are retired? In working with clients through this, the best answer depends on your financial circumstances as well as your relationship with the deceased.
Let’s dive in to gain more clarity about the rules and how they pertain to you.
The following information covers distribution rules for a Traditional IRA, SEP IRA, or SIMPLE IRA.
Eligible Designated Beneficiaries (EDBs)
Certain beneficiaries can “stretch” distributions over life expectancy rather than being forced to clear the account in 10 years. These include:
- A surviving spouse
- The IRA owner’s minor child (until age 21, at which point the 10-year rule begins)
- Disabled individuals
- Chronically ill individuals
- Any individual not more than 10 years younger than the IRA owner
Example
Let’s say that Sarah, age 55, inherits an IRA from her recently deceased husband with a value of $500,000. As a spouse she has options that are unique to being an Eligible Designated Beneficiary. She has the option to roll the inherited IRA into her own IRA and defer any distributions until when she is required (currently 73).
Value of IRA at 55 – $500,000
Value of IRA at 73 – $700,000
The first distribution at 73 would be $13,200 using the IRS Uniform life expectancy table)
If she leaves the Inherited IRA as it is – she needs to start taking annual distributions based on her life expectancy.
Rules for Non-Eligible Beneficiaries
If you are an adult child, friend, or other non-spouse beneficiary who does not meet one of the categories above, the following rules apply:
1. 10-Year Rule: The account must be fully distributed by December 31 of the 10th year after death.
2. Distributions:
- You must pay income taxes on each distribution from a Traditional, SEP, or SIMPLE IRA.
- You are only required to take annual distributions if the deceased had already begun taking their Required Minimum Distributions (RMDs).
- However, it may make sense to take annual distributions anyway to spread out the tax burden.
- If the deceased had begun taking RMDs, then you must also continue them, based on the following formula:
Value of the IRA ÷ Remaining Life Expectancy (per IRS table)
Example
Let’s say a 40-year-old inherits a $500,000 IRA from their parent’s estate. The IRS Single Life Expectancy Table gives a factor of 43.6.
$500,000 ÷ 43.6 = $11,468 RMD
As you can see, by only taking the required minimum distribution, you will still have a significant balance in year 10.
A Note About Roth IRAs
Inherited Roth IRAs follow the same beneficiary rules (10-year rule for most, stretch for EDBs), but qualified Roth distributions are generally tax-free. This makes the timing decision less about taxes and more about investment planning.
Most Importantly, Don’t Rush the Decision
While the rules may seem straightforward on paper, in practice the right approach depends on your income, tax bracket, long-term goals, and whether the IRA is Traditional or Roth. Inheriting an IRA is not just a financial decision, it’s an emotional one too, because it often represents a legacy left behind.
The key is to make informed choices rather than quick ones. Take time to understand the options, spread distributions in a way that aligns with your life, and know that we are here to help guild you through the process when you are ready. Every situation is unique, and we are here to help you make the decisions that are right for you.
Reach out if we can answer questions or help clarify your options.
