Clark Stott has been with Expat Tax Online since 2015. Being a dual national based in the UK, Clark has unique experience helping US citizens (and Accidental Americans) become tax compliant via the Streamlined Tax Amnesty program. Clark likes to help Americans in the UK keep their tax situations as simple as possible to avoid harsh IRS treatment.
Table of Contents
What happens when you receive an inherited IRA?
You become a beneficiary of the individual retirement account (IRA) and can receive benefits from it.
An IRA is a savings plan that lets you set aside money for retirement with a tax advantage.
What makes you a beneficiary?
When the owner of the IRA chooses you to benefit from the IRA upon their death, you become a beneficiary. A beneficiary can be an individual or an entity.
Types of Beneficiaries:
- Spouse
- Non-spouse individuals: named beneficiary aside from a spouse.
- Trusts: If a trust is chosen as a designated beneficiary of an IRA, the individuals within the trust will be considered the designated beneficiaries.
- No designated beneficiary: Like non-designated trusts, charities, or estates. They are treated as not a designated beneficiary even if it is a named beneficiary.
What can beneficiaries gain from inheriting an IRA?
Beneficiaries can claim “distributions” from the inherited IRA. This is done by withdrawing funds from the IRA account.
However, the distributions must be included in their taxable income for the year they claimed them, as they are generally spread based on their life expectancy.
Required Minimum Distributions (RMDs)
Required Minimum Distributions (RMDs) are the minimum amounts that must be withdrawn by the owner of the IRA every year starting at age 72 (or 73 for those who turn 72 after December 31, 2022).
How are distributions managed for spousal beneficiaries?
The surviving spouse generally has three options:
- Continue as a beneficiary
- Roll over to another IRA or a taxable plan such as:
- Qualified employer plan
- Qualified employee annuity plan
- Tax-sheltered annuity plan
- Deferred compensation plan of a state or local government
- Treat it as their own IRA: continuing the account as their own will only be considered if:
- A continuing contribution is made to the inherited IRA (including rollover contributions).
- RMDs are not claimed for a year as a beneficiary of the IRA.
Still, some of these options need to follow Required Minimum Distributions (RMDs).
Required Minimum Distributions (RMDs) for Spousal Beneficiaries
- Continuing as a beneficiary:
- If the original owner started claiming RMDs, the beneficiary should begin to receive them by December 31 of the year after the owner’s death.
- If the original owner had not started claiming RMDs, the beneficiary could delay distributions until the year the deceased owner would have turned 72.
- Treating it as their own:
- RMDs will be based on the new owner’s age; the same rules apply to an IRA owner.
How are distributions managed for non-spousal beneficiaries?
Non-spousal beneficiaries are not required to claim the Required Minimum Distributions (RMDs) from the IRA account.
However, they should withdraw all distributions from the inherited IRS within ten years after the original owner’s death, also known as the “10-year rule.”
In some situations, a group of eligible designated beneficiaries are exempt from the 10-year rule. Individuals such as:
- Disabled individuals
- Chronically ill individuals
- Minor children of the original owner (until they reach the age of majority)
- Beneficiaries not more than ten (10) years younger than the original owner
How are distributions managed for trusts?
After the owner’s death, the required minimum distributions (RMDs) will be determined by the life expectancy or status of the trust beneficiaries, not the trust itself.
Are my distributions taxed?
Yes, distributions from an inherited IRA are generally taxed as ordinary income.
A traditional IRA allows you to postpone paying taxes upon contributing. Then, once you receive your distributions, it will be added to your taxable income for the year.
What distinguishes a traditional IRA from a Roth IRA?
The difference between the two retirement accounts is the treatment of tax obligations.
For traditional IRAs, the owner contributes with pre-tax dollars, postponing taxes upon contribution. The distributions are then included in the gross income, which can be subject to a tax deduction.
For Roth IRA, the owner contributes with after-tax dollars. The distributions will not be included in the taxable income for the year, which also does not qualify for tax deductions.
Can a beneficiary choose not to accept an inherited IRA?
Yes, the beneficiary can disclaim the IRA inheritance.
If a named beneficiary plans to decline the inheritance, they must submit a written, irrevocable, and unconditional refusal within nine (9) months of the original owner’s death.
What happens if there are several beneficiaries?
Multiple individual beneficiaries have the freedom to keep the combined account or split it into separate accounts for each beneficiary.
- Combined account: The distribution rules will be based on the oldest beneficiary.
- Separate accounts: The IRA will be divided to each beneficiary by December 31 of the year following the original owner’s death. Each beneficiary can choose their distribution method and take distributions based on their own life expectancy or under the 10-year rule.
What happens if a minor is the beneficiary of the IRA?
A minor beneficiary is considered an eligible designated beneficiary.
They are under special rules in claiming distributions:
- Required Minimum Distributions (RMDs): Minor beneficiaries can start taking RMDs after the original owner’s death and continue until they reach the age of majority, typically 18 or 21, depending on state law.
- 10-Year Rule: Upon reaching the age of maturity, the beneficiary must claim the remaining balance of the IRA within ten years.
These rules are made to ensure proper management of the inherited IRA for minor beneficiaries.
