Inherited IRAs: What to Know About Taxes, RMDs, and More

Some people like to imagine the ideal windfall: A surprise (and tax-free!) inheritance from a distant relative whom you barely remember or never met.

It’s much less fun to think about navigating a more typical bequest—an inherited IRA, which arrives laden with rules to follow, required minimum distributions, and possible tax complications.

The situation can get even more tangled when you incorporate your relationship with the benefactor. That connection will determine—or limit—your choices for managing distributions of the funds. Add in recent revisions to the rules around inherited IRAs, and a windfall can start to feel weighty. “There’s just so much going on,” says Ed Slott, a tax and retirement planning expert. “It’s easy to inherit. It’s hard to know when to take the money out.”

It’s no surprise that some people opt to take an IRA inheritance in cash, accept a tax hit, and avoid dealing with RMDs altogether.

“I’ve seen some heirs that will cash it in pretty quickly and buy cars and trucks and add swimming pools to their houses, and spend it as soon as they get it,” says Sheryl Rowling, director of financial advice for Morningstar. “Others have more of a long-term view, that maybe they’ll take some money out to help them with a down payment on a house, and with the rest of it, they’ll try to make the most of it.”

The key to managing your inherited IRA well is understanding your options at each step of the process, from inheriting, to transfers or rollovers and management, to taking distributions.

Inherited IRAs: Which Type of Beneficiary Are You?

Your obligations and options as a beneficiary depend on your relationship with the IRA owner. Under current laws, IRA beneficiaries fall into three categories:

Source: IRS Publication 590-B (2023), Distributions from Individual Retirement Arrangements (IRAs).

The category that applies to you will help determine how you can move the inherited money and how you calculate any RMDs, which comes into play at tax time.

Inheriting an IRA From Your Spouse

Spouses benefit from having the most options for their inherited money. Spouses may keep the assets in a beneficiary IRA, transfer it to their own IRA, or roll it to their own IRA or employer plan account.

“The election by the spouse beneficiary of an IRA will affect the rate at which distributions must be taken and the income tax owed,” says Morningstar contributor Denise Appleby, author of the IRA Quick Reference Guide.

If you opt for rolling over an inherited IRA, having a knowledgeable financial advisor can be key to avoiding costly mistakes.

Inheriting an IRA From Your Sibling

For nonspousal eligible designated beneficiaries of the IRA owner—such as their siblings (of less than 10 years’ age difference), their minor children, or their disabled/chronically ill heirs—there are a few points to note. As this type of heir, you can take distributions over your life expectancy, or the decedent’s life expectancy if they died while taking RMDs and they were younger than you, Appleby says.

Under newly streamlined IRS regulations, if you are inheriting an account where the benefactor was taking RMDs, you must make annual withdrawals. If you are not an EDB, you must empty the account by the 10th year. However, if the IRA was bequeathed by someone who was not required at time of death to take RMDs, the heirs can take withdrawals until the end of the 10th year if they are not an EDB, or if they are an EDB who opts to use the 10-year rule instead of taking annual distributions over their life expectancy. (See more details below.)

Unlike spousal beneficiaries, nonspouse EDBs cannot roll over the account into their own IRA. The account has to remain an inherited IRA.

Inheriting an IRA From Your Parent

Recent changes to the Secure Act affect designated beneficiaries, which is probably most people who inherit IRAs—for example, adult children of the IRA owner, who are not disabled or chronically ill. In addition, the money has to be paid out under a time limit (the “10-year rule”). That means the inherited account must be fully distributed by the end of the 10th year after the account was inherited. In addition, the “stretch IRA” option that some people use to defray taxes is no longer an option for such nonspouses, but they must take annual RMDs if the IRA owner died in RMD status.

“It’s not an easy calculation, so whoever inherits an IRA probably wants to talk to a tax consultant or financial planner,” says Rowling.

Inherited IRAs: Tips on Taxes, RMDs, and Other Considerations

For those who are trying to decide what to do with their inheritance, Rowling suggests finding a fee-only advisor or financial professional who can help you sort out your options.

Whether you take a lump-sum payment from an inherited IRA or choose to maintain it, tax obligations should figure into any decisions you make about your inheritance.

“It becomes an important tax-planning situation,” Rowling says. “If you have to take a minimum amount, do you take more than that minimum amount and maybe work with other deductions? Or do you want to spread it out evenly? It’s a very detailed calculation, based on the new rules.”

For people who are subject to the 10-year rule, what kind of strategies should they be thinking about to mitigate the tax impact of required distributions?

Work with a tax consultant or financial planner on a strategy that works best for your unique life situation, Rowling says. “Let’s say I inherit an IRA, and I’m working for three more years and then I’m going to retire. I would probably want to take the minimum during the first three years, and then maybe I want to take more out until I start taking RMDs on my retirement plan,” she says. “It’s really a tax-planning situation to see what will make the most sense for you.”

Disclaiming an Inherited IRA

If this all sounds like more trouble than it’s worth, you can always opt out of the money.

Rowling says it’s a rare situation, but it does happen. “Sometimes, the children of the deceased are in a very good financial situation, and they might be in a position to disclaim it and let the grandchildren get it,” she says.

Appleby cautions that a beneficiary who disclaims an inherited IRA has no control over who gets it as a result of the disclaimer. Instead, she says, the beneficiary designation or the terms of the IRA agreement makes that determination. Therefore, one should be aware of which person or entity would inherit the amount before making a disclaimer.

For many people, however, turning down an inherited IRA isn’t an option. For others, it may provide retirement funds or money that they otherwise wouldn’t have.

“An IRA will benefit your heirs, no matter what—even if they’re in a higher tax bracket,” Rowling says. “Because unless the tax rates are 100%, they will still end up with more money in their pockets. But there are better and worse ways to approach it so that Uncle Sam gets less.”