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A closer look at inheriting IRAs

Inheritance of Individual Retirement Accounts (IRAs) is a growing trend. With nearly 40 years of history, IRAs have been around long enough now that many people are passing money to beneficiaries in this form at their death. This transfer of assets is rarely as simple as the beneficiaries hope. Intricate IRS withdrawal rules, and other account maintenance details, aren’t commonly understood and are frequently applied incorrectly. But IRAs can be a useful resource for financial security.

What to do with an inherited IRA depends primarily on whether or not the original account owner was already taking annual required minimum distributions, and whether the beneficiary is a spouse or not. With this information, you can determine how to best withdraw money from the account.

Any withdrawals made from tax-deferred portions of traditional IRAs are considered ordinary income, taxed at the marginal tax rate of the beneficiary. This may mean that the beneficiary will pay more tax on withdrawals than the original owner would have. However, while it is allowed, you do not need to withdraw assets in a single lump sum, incurring more substantial taxation.


In most cases, the way to ultimately withdraw the most money from an inherited IRA is to make annual required minimum distributions (RMDs) based on life expectancy.

▪ If the original IRA owner died after already beginning RMDs (generally after age 70 1/2), then the future required distribution will be based on the life expectancy of the original owner or the beneficiary, whichever is longer, as reported on the IRS Uniform Life Table.

▪ If the original owner died before starting RMDs, then the beneficiary may use their own IRS-determined life expectancy to identify the amount that needs to be withdrawn each year.

▪ Alternatively, a beneficiary may choose to follow a “five-year rule.” As long as all the money is withdrawn from the inherited IRA by Dec. 31 of the fifth year after the date of death, no annual schedule needs to be followed.

The required distribution is calculated by dividing the prior year-end account balance by the IRS life expectancy, reducing the life expectancy number by one each year. Unfortunately, the account custodian will not calculate RMDs for inherited IRAs the way it will for living account holders. It is up to the account owner to determine the correct amount and withdraw it from the account by the end of the year.

Spousal beneficiaries have their own rules. Spouses are the only beneficiaries who have the option to transfer inherited IRA assets into their own IRA. Other beneficiaries, while having ownership of the new inherited IRA, must keep it titled in the name of the original owner. Either way, beneficiaries of the original IRA have the opportunity to name their own successor beneficiaries.

It’s important to note that IRAs act as a contract between the account owner and the beneficiary. This means that the designated beneficiary receives the assets regardless of any conflicting direction that may be included in a will.


In many cases, the younger the beneficiary, the more valuable the inherited IRA. For instance, a 30-year-old beneficiary following an annual required minimum distribution schedule could double lifetime withdrawals compared with a 50-year-old beneficiary of the same account because of compounding growth and tax deferral.

Stretching the IRA through multiple generations is attractive; however, this practice is continually under scrutiny as a tax reform item and could be limited in the future.

Roth IRAs are best for stretching because of their after-tax character. Beneficiaries of Roth IRAs must make withdrawals, but these distributions are not subject to ordinary income tax.

Regardless of the type of IRA inherited, or the withdrawal strategy, it is important for the beneficiary of the account to re-evaluate its investments. Especially when inherited by the next generation, it’s possible that the inherited investments might not fit the objective of the new account owner as well as they did the original owner. Personal fit and alignment with your own goals is usually more important than holding onto investments for sentimental or legacy reasons.

As with many personal finance topics, there are other less common factors or decision points that may be important in specific circumstances, such as when the inheriting spouse is more than 10 years younger, when nondeductible contributions have been made to the IRA over time or when multiple beneficiaries need to split inherited IRAs. Effectively making withdrawal decisions can make a big difference in the ultimate amount inherited over time.

Gary Brooks is a certified financial planner and the president of Brooks, Hughes & Jones, a registered investment adviser in Gig Harbor. Follow him on Twitter @moneyarchitects.