8 Things You Need To Know About Your Inherited IRA

By Sarah Brenner, JD
Director of Retirement Education
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A significant percentage of IRA assets will ultimately go to nonspouse beneficiaries. When these beneficiaries inherit the funds, special rules kick in. Inherited IRAs are not like other IRA accounts. Here is what you need to know if you inherited an IRA from someone who is not your spouse:

1. You should consider all your options before doing anything with your inherited IRA. If you inherit an IRA, you need to move cautiously. You have time to make decisions, so don’t rush. You will want to notify the IRA custodian of the death of the IRA owner if that has not already happened. You will also want to be sure that the beneficiary account is set up properly. Each custodian will do things a little differently, but you will want to make sure that the account is titled with you as the beneficiary of the deceased IRA owner. This is not a taxable event.

Do not take any distributions unless you are sure that is what you want. Distributions cannot be put back if you change your mind and there are likely to be tax consequences. An unwanted or unneeded distribution is a mistake that cannot be fixed.

2. You cannot contribute to your inherited IRA. You cannot make contributions to an inherited IRA. If you already have your own IRA, you cannot add those funds to the Inherited IRA or vice versa.

3. You can transfer your inherited IRA. If you are unhappy with the investment choices or the custodian, you can transfer your inherited IRA to another custodian, and you can select different investment options. You must move the account by direct transfer and the new account must be an inherited IRA as well. As a nonspouse beneficiary you cannot take a distribution and then roll it over within 60 days.

4. You may be able to do a QCD. If you are charitably inclined, you may be able to take advantage of a qualified charitable distribution (QCD) and move your IRA funds directly to the charity of your choice in a tax-free transfer. To do a QCD you must be 70 ½ or older.

5. You cannot convert your inherited IRA. Many times, nonspouse beneficiaries are interested in having a Roth IRA. Unfortunately, the rules do not allow nonspouse IRA beneficiaries to convert inherited IRAs to Roth IRAs.

6. You will be subject to RMDs. You can’t keep the funds in your inherited IRA forever. Your account will be subject to required minimum distributions (RMD)s. If you inherited the IRA funds in 2020, as a nonspouse beneficiary you will most like be subject to a 10-year payout-period (which is essentially one big RMD at the end of the 10 years). Certain eligible designated beneficiaries who inherit in 2020 and those beneficiaries who inherited prior to 2020 may be still be able to stretch RMDs over life expectancy.

7. Your distributions may be taxable, but there will be no penalty. Inherited IRAs are never subject to the 10% early distribution penalty. However, if you inherit a traditional IRA it is likely that the distributions you take will be taxable. If you inherit a Roth IRA, you are more fortunate from a tax perspective. Distributions from an inherited Roth IRA will most likely be tax-free.

8. You should name a successor beneficiary. When you inherit an IRA, it makes sense to name a beneficiary. If you don’t, the default provisions in the IRA document are likely to apply. In many cases this would mean the funds would go to your estate which can mean more taxes and the time and expense of probate.