The Do’s and Don’ts of Inherited IRAs

By Vincent R. Birardi, CFP^®, AIF^®, Wealth Advisor at Halbert Hargrove featured in Kiplinger 

When you inherit an IRA, you likely have a lot of questions. Do you need to take RMDs? When? How long do you have before the account must be cleaned out?

There’s been significant buzz recently focused on the expected transfer of approximately $72 trillion (yes, trillion with a T) of personal assets in the United States over coming years from baby boomers to younger generations. While this may seem to negate the need for pre-retirees to plan for their own retirements (spoiler alert — it doesn’t), it does highlight the significant role inherited IRAs play in wealth transfers between generations.

There are two types of inherited IRAs: traditional and Roth. An inherited traditional IRA is a tax-deferred investment account that is used as the vessel to receive assets coming from another tax-deferred investment account (e.g., traditional 401(k)s and traditional IRAs).

By comparison, an inherited Roth IRA is an after-tax investment account used to receive assets from a Roth 401(k) or Roth IRA.

To help you decide how to handle being the owner of an inherited IRA, I’ve compiled three common questions I receive from my clients and my current guidance on the matter.

1. What are the current distribution rules and tax impacts for inherited traditional and Roth IRAs?

For traditional inherited IRAs:

• If the assets received have come directly from your deceased spouse, you can liquidate the IRA over your lifetime — a tax-minimizing strategy called a “stretch IRA.” You will only be on the hook to take annual required minimum distributions (RMDs), which will be treated as taxable income for you.
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• However, in most cases, if the assets were received from anyone else (for example, a deceased parent), then you can no longer do a stretch IRA. Instead, you must liquidate the entire account within the next 10 years.
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  (This unfortunate window was passed into law in 2019 under the SECURE Act, and it applies to inheritances received starting in 2020.) There are a few exceptions to the 10-year rule, including minor children (but not grandchildren) of the IRA owner, and people who are chronically ill or disabled. These folks can all still do a stretch IRA.

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For inherited Roth IRAs:

• Basically, the same conditions above apply; however, any distributions taken are not taxed.

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