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Understanding Inherited IRAs

At first glance, the rules surrounding inherited IRAs are complex. Here are some questions (and potential answers) to consider if you have inherited one or may in the future.

Who was the original IRA owner?

If the original owner was your spouse, you have a fundamental choice to make. You can roll over your late spouse’s IRA into an IRA you own, or you can treat it as an inherited IRA. If the original owner was not your spouse, you must treat the IRA for which you are named beneficiary as an inherited IRA. (1,2)

What kind of IRA is it?

What kind of IRA is it? It will either be a traditional IRA funded with pre-tax contributions or a Roth IRA funded with post-tax contributions.

Do you want to let the money grow and take RMDs or cash it all out now?

In the case of a small IRA, many heirs just want to cash out – it seems bothersome to schedule tiny withdrawals out of the IRA across the remainder of their lifetimes. Money coming out of an inherited traditional IRA is taxable income, however – and if a lump sum is taken, the tax impact could be notable. (1)

If the IRA is substantial, there is real merit in scheduling Required Minimum Distributions (RMDs) instead. This gives some of the still-invested IRA balance additional years to grow and compound. Any future growth will be tax deferred (traditional IRA) or tax free (Roth IRA). (1)

Internal Revenue Service rules say that RMDs from inherited IRAs must begin by the end of the year following the year in which the original IRA owner died. These RMDs are required even for inherited Roth IRAs. Each RMD is considered regular, taxable income. (1,2)

One asterisk is worth noting regarding inherited traditional IRAs. If the original IRA owner died on or after the date at which RMDs are