Inherited an IRA? Know your options as a beneficiary.
Dealing with the loss of a loved one is never easy. And it can be even more challenging if there are decisions you need to make about money they’ve left behind.
If you’ve found yourself listed as a beneficiary on a loved one’s Individual Retirement Account (IRA),1 you may be entitled to some or all of the money. Here’s some information to help you understand your options and decide how to move forward.
What are your options as an IRA beneficiary?
Depending on your relationship to the original account holder, you may have up to 4 options to choose from.
1. Transfer the money to an inherited IRA
One option is to transfer the inherited IRA proceeds into an inherited IRA in your name. This is a type of retirement account that can only be opened by a beneficiary.
An inherited IRA allows you to keep the money invested in the market; however, you can’t contribute more money to the account. Your inherited IRA must match the type of the original account—a traditional IRA must move to an inherited traditional IRA, and a Roth IRA to an inherited Roth IRA.
You’ll need to decide when, and how, you’ll withdraw money from your inherited IRA. If the original IRA owner had not yet reached their required beginning date2 to start taking required minimum distributions (RMDs), the IRS gives you 2 withdrawal options:
- The 5-Year Rule—You must withdraw all of the money in the IRA by December 31 of the 5th year following the original account owner’s passing. The amount and frequency of the withdrawals is up to you.
- The Life-Expectancy Method—You withdraw a set amount (RMD) from the account each year. The amount of the distribution is determined by a calculation based on your life expectancy in the year following the original IRA owner’s death.3
If you use the Life-Expectancy Method, the inherited IRA could potentially become an ongoing income stream to you. On the other hand, if you know you want to withdraw all of the money from the inherited IRA in a relatively short amount of time, you might choose the 5-Year Rule, and plan to take the largest distribution in a year where you foresee your income being lowest.
You’ll also need to name beneficiaries for an inherited IRA. If you pass away before it’s depleted, the remaining money will be passed on to the beneficiaries you designate. Passing IRA money from an original account holder to multiple generations of beneficiaries is called “stretching an IRA” and is a way to provide income across generations.
If the original IRA owner had reached their required beginning date the 5-Year rule is not an option. Instead you must withdraw using the Life-Expectancy Method.4
2. Treat the account as your own (surviving spouse only)
If you’re the spouse of the original IRA owner, you have the unique option to treat the account as if it was your own, which means you move the money into an IRA in your own name. By doing this, you avoid having to withdraw money from the account within a certain time frame, like you would if you moved the money into an inherited IRA. Instead, you’d follow RMD rules as if you were the original owner of the IRA (beginning RMDs when you reach age 70½). With this option, the money remains invested and you can continue to make contributions to the account if you have earned income.
Keep in mind, if you choose the “treat as own” option, you may pay a 10% early withdrawal penalty if you withdraw any cash from your IRA prior to age 59½. If you’re under 59½ and want to withdraw some cash without penalty, you could initially move the money into an inherited IRA, withdraw money as needed, and then move the account to an IRA in your own name to defer your RMDs until you reach age 70½.
3. Take a total cash distribution of the IRA
Another option is to take a total cash distribution—withdrawing all of the money and closing the account. While this option is often the simplest (since you don’t have to worry about keeping track of your inheritance down the road), there are a couple things to consider.
- If the account is a traditional IRA, you’ll have to pay taxes on the money at the time you withdraw it. This could put you in a higher tax bracket for the year, because that money is counted as income. (If the account is a Roth IRA, the distribution will generally be tax-free, but there are some limited instances where a portion of the distribution could be taxable.)
- Typically, money in an IRA is invested in the market. When you decide to take the money as cash, you’re giving up the opportunity for that money to potentially grow.
4. Disclaim the inherited account
One last option is to disclaim the inheritance. Choosing to disclaim means you are declining to accept the money left to you.
Turning down money might sound unusual, but sometimes it’s the right option if you don’t need the money and would rather the IRA proceeds pass to someone else. (You’re not able to choose who receives the disclaimed money.)
When it’s time to decide, help is available
Deciding what to do with an IRA you inherit is an important and complicated decision, often made at a difficult time. It may be best to get professional help from a financial advisor, tax advisor, or attorney. That person can help you make the right decision for your situation.
- If you inherited a Principal IRA, we can help you understand your options and decide what to do. Give us a call at 800-986-3343.
- Talk with your financial professional about your inherited IRA options. Don’t have a financial professional? We can help you find one.
- Make sure your own loved ones are protected if the unexpected happens. Log in to review and update your beneficiaries on any Principal accounts
1 The term IRA includes both Individual Retirement Accounts and Individual Retirement Annuities.
2 Required beginning date is defined as April 1 of the calendar year after the IRA owner reaches age 70½.
3 Special favorable rules may apply to the surviving spouse of the original IRA owner.
4 If the original IRA owner was younger than beneficiary then RMDs can be calculated using original owner’s life expectancy.
Investing involves risk, including possible loss of principal.
The subject matter in this communication is educational only and provided with the understanding that Principal® is not rendering legal, accounting, or tax advice. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, or accounting obligations and requirements.
Financial professionals are sales representatives for the members of Principal Financial Group®. They do not represent, offer, or compare products and services of other financial services organizations.
Insurance products and plan administrative services provided through Principal Life Insurance Co. Securities offered through Principal Securities, Inc., 800-547-7754, member SIPC. Principal Life and Principal Securities are members of Principal Financial Group®, Des Moines, IA 50392.