If you inherit a retirement account, particularly a traditional IRA or a Roth IRA, you have some decisions to make. Unlike some inherited property, which you can just set aside until you are ready to deal with it, retirement accounts require timely action on your part, while you may still be dealing with the grief of the loss of the person whose account you inherited.
Fortunately, you don't need to take that action on your own. An estate planning and probate attorney can give you the advice you need in order to make those decisions, and the guidance you require to carry them out. In the meantime, here are some general basics to help you understand your options.
What you can (or must) do with your inherited retirement account depends primarily on three factors: whether the IRA is traditional or Roth; whether or not you were the spouse of the owner, and whether or not the owner had reached the age of 70 1/2 when he or she was required to begin taking required minimum distributions (RMDs).
If you are the account owner's surviving spouse, you have several choices if you are the only beneficiary of a traditional IRA from your late spouse. You can take a taxable lump sum distribution. While subject to income tax, there is no 10% penalty for early distributions prior to age 59 1/2, as there would have been for your spouse. You can keep the IRA, treating it as your own. If you have your own traditional IRA, you can even roll the inherited one into it. Either way, however, there are the usual penalties for withdrawals taken before you turn 59 1/2. Assets in the IRA will continue to grow tax-deferred.
Alternately, you can choose to take annual distributions from your late spouse's IRA over your lifetime. As with the lump sum option, these are subject to income tax, but there is no penalty for early withdrawal regardless of whether you have reached age 59 1/2. When distributions must begin depends on your late spouse's age: you must begin taking distributions no later than the later of December 31 of the year in which your late spouse would have turned 70 ½, or December 31 of the year following the year of their death
The last option is a five-year spend down. With this option, you must take distributions of the full amount of inherited assets in the IRA over a five year period. Like the lump sum and annual distribution options, distributions are taxable, but not subject to the penalty for distribution if you, as inheriting spouse, take distributions before age 59 1/2.
If you inherit a Roth IRA from your deceased spouse, you have similar options. The good news is that as long as the Roth IRA is more than five years old, distributions are tax-free. With a Roth account, you can choose to treat the inherited account as your own, take tax-free distributions of the entire amount over five years, take tax-free distributions for your lifetime, or elect a lump sum distribution. Be aware that if you choose a lump sum option or five-year option and the account is less than five years old as of your spouse's death, account earnings are taxable upon distribution.
With a traditional IRA, a non-spouse beneficiary such as a child or grandchild may not treat the inherited retirement account as their own, unlike a surviving spouse. However, they still have the other three options. They can choose distributions over their life, elect to take distributions of all account assets over a five year period, or take an immediate lump sum distribution. As with spouse beneficiaries, distributions will be taxable in each of these three scenarios, but will not be subject to the 10% early withdrawal penalty.
Likewise, with a Roth IRA, a non-spouse beneficiary is not entitled to treat the assets as their own, but can choose lifetime tax-free distributions. They may also elect a five year distribution period or a lump sum distribution, but earnings will be subject to tax if the account was less than five years old at the original owner's death.
The rules surrounding IRAs and Roth IRAs are much more complicated than we have room to address in this blog post. If you inherit a retirement account from a loved one, you are encouraged to promptly discuss your options with an attorney who understands and can counsel you regarding tax and other financial implications.
You may also be interested in: