What you need to know about inheriting an IRA

Handling an inherited IRA can feel overwhelming, especially if you’re simultaneously coping with the loss of a loved one. Fortunately, figuring out what to do doesn’t have to be complicated. The key is to answer two basic questions:

  • What type of IRA are you inheriting?

  • Do you need immediate access to some or all of the funds?

Understanding your options and the tax implications related to them can help you make the most out of the inheritance entrusted to you.

What are my options?

In general, you can treat inherited IRAs one of three ways:

  • If you inherit the IRA from your spouse, you can simply take ownership of it and treat it as if it were your own.

  • You can choose to take all the money out of the IRA in a lump sum.

  • You can hold some or all of the money in the account for 10 years, at which point you will need to withdraw the remainder.

The method that will work best for you depends in part on the type of IRA you have inherited.

Traditional vs Roth IRAs

Both traditional and Roth IRAs offer tax advantages as incentives to save for retirement:

  • Contributions to Traditional IRAs are generally tax-deductible and can grow tax-deferred, but when you withdraw the money, it is taxed as regular income.

  • You don’t receive any tax break on contributions to a Roth IRA. You potentially won’t have to pay taxes on withdrawals in retirement, meaning any investment growth may be tax free.

Another difference: Holders of Traditional IRAs have to take required minimum distributions (RMDs) when they reach the age of 73, but Roth IRA owners do not.

If you have inherited a Roth IRA

With a Roth IRA, you can withdraw the original contributions tax-free at any time. If the account has been open for at least five years, you can also withdraw investment gains tax-free. If the account is less than five years old, you’ll be taxed on withdrawals of investment gains

Example: Abby dies in 2024 with a balance of $100,000 in a Roth IRA she opened in 2018. Her beneficiary, Ben, selects the lump-sum distribution method in 2024. Since Abby opened the account more than five years ago, the money is tax-free.

In general, your financial situation will drive the decision about what to do with an inherited Roth IRA. If you need the money and the account has been open for more than five years, you can make withdrawals without worrying about taxes. But if you want to maximize your inheritance, you may want to keep your money invested as long as possible (up to 10 years) to take advantage of additional opportunities for tax-advantaged compound growth.

If you have inherited a Traditional IRA

Withdrawals of tax-deductible contributions and earnings from a Traditional IRA are considered taxable income, meaning they get added to your tax return for the year of the withdrawal. Depending on your financial situation, this extra income could bump you into a higher tax bracket, increasing your income tax bill and potentially affecting other aspects of your financial life, such as eligibility for college financial aid.

Example: Traditional IRA owner Abby dies in 2024 and has one beneficiary, Ben, for a $100,000 IRA. Ben selects the lump-sum distribution method in 2024, so $100,000 is added to his taxable income for that year.

It’s important to keep these tax consequences in mind, whether you are considering taking a lump sum distribution now or leaving money in the account. Depending on your tax rate and the amount of money in the account, it could be advantageous to take regular distributions from an inherited IRA over 10 years whether you need the funds or not.

Also, remember to consider RMDs. If the original owner of the IRA was already taking RMDs, you need to continue taking them. And if you assume ownership of a Traditional IRA from your spouse, you will need to take RMDs when you reach age 73.

Example: Ida, 74, and John, 69, are married. Ida dies, and John inherits her

$100,000 traditional IRA. As a surviving spouse, he chooses a spousal rollover, and the $100,000 IRA is retitled in his name. When John turns 73, he will need to take an RMD (required minimum distribution), the minimum amount he must withdraw from the retirement account each year.

It’s a good idea to speak to a tax advisor or a financial planner to make sure you understand and plan for the potential tax consequences of an inherited IRA.