As anyone who has experienced the death of a person close to them can attest, there is a mountain of paperwork that comes with death. Deciding what to do with any retirement accounts that you may inherit is one such example.
This article focuses on the beneficiary (the person receiving the assets), not the executor or administrator (the person who distributes the assets)—although in many instances these are the same person.
When you inherit an individual retirement account (“IRA”), your options depend on your relationship to the decedent, the year of death, and whether the decedent died before or after required minimum distributions (“RMDs”) were set to begin. This article outlines the options available when you inherit an IRA from someone besides your spouse (for example, a parent). Read my companion article if you want to review the options available when you inherit an IRA from your spouse.
Whether someone is your spouse as of the date of their death depends on state law. If you are unsure, consult an attorney.
The year of death factor considers whether the decedent died in 2019 or before, or 2020 or later. This matters because the law changed—allowing for more favorable options—as of January 1, 2020. (I am still including the “2019 or before” information because many folks are still dealing with such accounts.)
The RMD factor considers whether the decedent died on or after their RMD beginning date.
An RMD is the minimum amount that must be withdrawn from the IRA each year.
A person’s RMD beginning date is the deadline for their first RMD.
Because a person’s RMD beginning date is based on their age, you can calculate this yourself if you know their date of birth. If you do not already know the decedent’s date of birth, a copy of their birth certificate or death certificate will contain this information. (Be sure to keep copies of these documents in a safe place.)
This table shows your options when you inherit an IRA from a non-spouse. The key difference between spousal and non-spousal beneficiaries is that non-spouse beneficiaries cannot treat the account as their own IRA; the only option is to treat the IRA as an inherited IRA.
A special note regarding Roth IRAs: Because inherited Roth IRAs are subject to the same RMDs as inherited traditional IRAs, the above table applies whether you inherit a Roth or traditional IRA.
Another note regarding Roth IRAs: Remember that withdrawals of Roth IRA contributions are always tax-free. Most withdrawals of earnings from an inherited Roth IRA are also tax-free, but withdrawals of earnings may be taxed if the Roth account is less than five years old. Each conversion also has its own five-year clock, so if you convert a traditional IRA to a Roth IRA, you must wait five years to avoid taxation. Get an account history for the last five years preceding death and review it with a tax professional to verify the age of the account.
What is an eligible individual, other individual, and non-individual?
An “eligible” designated beneficiary is one of the following:
Spouse
Minor child (i.e., under age 18)
Disabled or chronically ill individual
Individual who is not more than ten years younger than the IRA owner or plan participant
Note that spousal beneficiaries have the options outlined in my separate article discussing spousal beneficiaries, which include all the options outlined here as well as other potentially more favorable options.
An “other individual” designated beneficiary is any individual (i.e., a human being) beneficiary that does not qualify as an eligible beneficiary. The most common non-spouse beneficiary of a retirement plan is an adult child. An adult child is not an “eligible” beneficiary; as an “other individual” designated beneficiary, their only option is the ten-year rule (for deaths occurring in 2020 or later).
A non-individual beneficiary is any beneficiary that is not a human being. Common examples are a trust, the estate of the decedent, or a charitable organization.
If the decedent fails to designate a beneficiary, or the beneficiaries decline the inheritance or die before the decedent, then the account passes to the estate of the decedent.
Options detailed
As you probably noticed from the table above, the most common option is to take RMDs based on your own life expectancy. Find your remaining life expectancy from Table I in Publication 590-B (based on your age as of December 31). Divide the prior year-end account balance by your remaining life expectancy. The result is your RMD for the current year. Be aware that your RMD must be calculated every year. Your IRA custodian can calculate this for you, and many IRAs have “automatic RMD” features you can utilize.
For example, if you will be 37 years old on December 31, 2023, your remaining life expectancy per Table I is 48.6. If the IRA account balance was $280,000 on December 31, 2022, your RMD for 2023 is $5,761 (i.e., $280,000 ÷ 48.6, rounded to the nearest whole dollar).
If you take RMDs based on the decedent’s remaining life expectancy had they lived the entire year, follow the same steps as your own life expectancy, except substitute the decedent’s would-be age as of December 31 for your own. If you are younger than the decedent, do not select this option; your own life expectancy will give you lower RMD amounts.
If you choose the five-year rule option, you must withdraw the entire balance by the end of the fifth year after the decedent’s death. If you inherit an IRA from someone that dies in 2023, you must withdraw the entire balance by December 31, 2028. (You may, but are not required to, take distributions prior to that date.)
The ten-year rule is exactly like the five-year rule, except with a longer time frame. If you inherit an IRA from someone spouse that dies in 2023, you must withdraw the entire balance by December 31, 2033.
RMD for the year of death
The above options outline the RMDs that will apply beginning in the year after the decedent dies. If a decedent dies in 2023, RMDs as outlined above will start in 2024.
In that situation, though, an RMD for 2023 may still apply. If the decedent would not have had an RMD for 2023 had they lived the entire year, then you have no RMD for 2023. If the decedent had an RMD for 2023 (or would have had one had they lived the entire year), then your RMD for 2023 is whatever portion of their RMD was not taken prior to death. For instance, if the decedent had a $785 RMD for 2023, but died before taking it, you must withdraw $785 from the inherited IRA by December 31, 2023. On the other hand, if they had already taken their full $785 RMD for 2023 before their death, then you have no RMD for 2023.
An excise tax penalty applies to the portion of any RMD not taken. The penalty can be lower if the shortfall is timely corrected, and may be waived entirely if you can establish that the shortfall was due to “reasonable error” and you are taking steps to remedy it. (This relief might be available if, for instance, the decedent dies near the end of the year.)
Additional considerations
There are some additional considerations (in no particular order) to keep in mind when weighing your options.
First, because RMDs do not apply to Roth IRAs while the account holder is alive, the “before RMD beginning date” options are available to Roth IRA beneficiaries. (Note that the “before” options generally include all the “after” options, plus extras.) That said, RMDs apply to Roth IRAs after the account holder dies.
Second, treating an inherited IRA as your own is an option that is only available to spousal beneficiaries.
Third, when you have an inherited IRA, you can either leave the account in place where it is or roll it over elsewhere. I typically recommend a rollover because it is easier to manage your accounts if you have them all in the same place. (For instance, I have a variety of retirement and non-retirement accounts at Vanguard.) If you roll it over, it would still be titled in the name of the decedent, with you listed as a beneficiary. For example: “Decedent FBO Beneficiary” (where FBO means “for the benefit of”). Be careful to ensure that it is set up properly! The brokerage where you want to hold the account can assist you with the specific steps required.
Fourth, you cannot roll RMDs over into another retirement account. An RMD must be a true withdrawal. Any RMD not taken by the required date is subject to an excise tax of up to 50%. It is no coincidence that the penalty for failing to take an RMD can be higher than the tax on that RMD.
Next, remember that your RMDs must be recalculated every year. This was mentioned above but it bears repeating. A distribution that exceeds your RMD in one year cannot be applied toward the RMD of a future year.
Relatedly, and perhaps most importantly, an RMD is exactly that—a minimum distribution. You can take more than the required minimum at any point. You can even empty the entire account at any point. Within a particular year, you do not have to wait until December 31 to take the RMD for that year; you can take it at any point, even on January 1. If the ten-year rule applies, for instance, you do not have to wait ten years to empty the account; you could empty the account in year four. You should always choose the option that gives you lower RMDs because it keeps your options open to the greatest extent possible.
Further, when weighing your options and planning your distribution schedule, consider the tax consequences of any distributions. Do not let that stop you, of course—I would rather have an extra $10,000 and be taxed on it than not have that $10,000 in the first place—just prepare accordingly.
One important tax consequence is that distributions from an inherited IRA are not subject to an early-withdrawal penalty. If you take a distribution from your own IRA before age 59.5, though, you will incur an early-withdrawal penalty unless an exception applies. If you own both an inherited IRA and your own IRA, using the inherited IRA first is generally a good strategy.
Finally, this discussion only applies to IRAs. If you inherit a retirement account besides an IRA—for example, a 401(k) account—your options will depend on that particular plan. Contact the plan administrator, and be prepared to provide a copy of the death certificate.
Which option is best for me?
Nobody can answer that question except for you. The best option depends on your long-term financial plan, which will necessarily vary from person to person. Consult a trusted advisor when weighing your options to make sure you get the best outcome.
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