An inherited IRA is an individual retirement account that is opened when you inherit a tax-advantaged retirement plan (including an IRA or a retirement plan such as 401 (k)) after the owner dies. An heir must generally transfer assets from the original owner’s account to a newly opened IRA on behalf of the heir. For this reason, an inherited IRA may also be referred to as a beneficiary IRA. If you’re the child, grandchild, sibling, distant family member, or even a close friend of an IRA owner who has named you as their beneficiary, it’s important that you and the owner of the IRA understand the rules that apply to IRA inheritances
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Inherited IRAs, also known as beneficiary IRAs, can be opened with inherited assets from traditional IRAs as well as from Roth, SIMPLE, SEP, or employee-sponsored retirement plans. If the IRA owner died with a large fortune on which federal inheritance taxes were paid, you, as the beneficiary, are entitled to a tax deduction for the portion of those taxes that is attributed to the IRA. It is important that the income tax treatment of the IRA remains the same from the original account to the inherited IRA. These rules don’t apply if you’ve simply transferred another IRA to your own IRA; they only apply to inherited IRAs
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As a beneficiary who is not a spouse, if you decide to transfer inherited IRA assets from the original owner’s IRA to an inherited IRA in your name, the assets won’t stay in your inherited IRA account forever. If you inherit a Roth IRA as a spouse, you have several options, including opening an inherited IRA. It’s also important to note that although the original owner of a Roth IRA doesn’t have to take RMDs over their lifetime, beneficiaries who inherit a Roth IRA must purchase an RMD to avoid penalties. Distributions from an inherited IRA can be taxed differently depending on the account type. For example, assets inherited from a Roth IRA are taxed differently than in a
traditional IRA.
Any type of IRA can be converted to an inherited IRA, including traditional IRAs and Roth IRAs, SEP IRAs, and Simple IRAs. A decision to reject IRA assets must be made within 9 months after the original IRA owner dies and before you take possession of the assets. When you receive a check, the money is generally taxed as ordinary income and cannot be deposited into an inherited IRA that you may own with another company or back into the inherited IRA from which it was originally withdrawn. The original account holder of a Roth IRA is never required to accept RMDs, but those who inherit Roth IRAs do so unless they fall into one of the
exemption categories.
As a beneficiary who is not a spouse, you don’t have the option to transfer inherited IRA assets to your own IRA. If the original IRA owner left a percentage of their IRA account to more than one beneficiary, it’s important that you divide up your portion of the deceased’s IRA in your name and then complete your first RMD by December 31 of the year after the
original IRA owner dies.
