Periscope: What Happens When Someone Inherits an IRA?

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Many people inherit an Individual Retirement Account (IRA). However, inheriting an IRA is not as easy as inheriting money outright. Read this Periscope to learn more about the IRS rules around inheriting an IRA*. And keep your eyes open for other Periscopes on what happens when someone inherits a spouse’s IRA.

Advantages of an Inherited IRA

One big advantage of an inherited IRA is that the beneficiary may defer income taxes. The IRA will either be a traditional tax-deferred IRA or it will be a Roth IRA. A traditional inherited IRA defers taxes until the beneficiary makes withdrawals. At that point, the beneficiary must pay taxes at their income tax rate. Importantly, a decedent does not pay income tax; the inheritor pays income tax.

In an inherited Roth IRA, the beneficiary never pays taxes again! The inheritor must make distributions, as discussed below, but the distributions are income tax free. For this reason, many retirees want to go tax free and leave their kids a Roth IRA; this is particularly powerful if the inheritors are in a higher income tax bracket than they are.

Disadvantages of an Inherited IRA

An inherited IRA forces the beneficiary to make distributions. The SECURE Act forces all of the money to be removed from an IRA within 10 years, or faster. The money withdrawn is subject to income tax, if it is a traditional inherited IRA. The inheritor may make withdrawals faster, if they so choose, but they must pull all the money out by the 10th year after the decedent’s death.

A second disadvantage is the Lifetime Expectancy Payment, LEP. The LEP forces the inheritor to make annual distributions based off their age. They will look up a factor in the IRS single lifetime table 1 and make an annual LEP. If it is a traditional inherited IRA, they will pay income tax on the distribution.

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* IRA stands for individual retirement account. An IRA provides tax advantaged retirement savings.

The tax information contained in this article is general in nature. Always consult an attorney or tax professional regarding your specific legal or tax situation.

About the author

Karl Frank, Certified Financial Planner ®, MSF, MBA, MA, is the President of A&I Financial Services LLC, a local business that specializes in wealth management, insurance planning, and retirement planning. Karl cares for business owners and the businesses that care for them. Learn More about Karl.