What Beneficiaries Need to Know about Inheriting Retirement Accounts

What happens to the assets of a traditional retirement account or an Individual Retirement Account (IRA) if the original owner dies?

The answer depends on the beneficiary’s relationship to the original owner of the IRA.

1. Spouses (or other designated beneficiary such as disabled, chronically ill or minor children* of the decedent)

There are generally two options when it comes to a spouse receiving beneficiary income.

• The spouse rolls over the inherited account to their own name in a new or currently held account.
  Most often, married individuals will name their spouses as beneficiaries of their retirement account(s) or spousal IRAs.  This option gives spouses the most control over the funds with the least amount of financial consequences. Spouses who inherit a retirement account generally choose to conduct a spousal rollover and move the money into their existing retirement account or IRA. When the rollover is complete, the inherited funds are subject to the same guidelines as the spouse’s own retirement assets.
• The spouse creates a beneficiary IRA in the deceased spouse’s name.
  A second option for the spouse is to create a beneficiary (decedent) IRA, which would provide more flexible withdrawal options. A beneficiary IRA remains in the deceased spouse’s name, and the living spouse can choose to take withdrawals without paying the early withdrawal fee. RMDs must begin at age 73 or in the year after the original account owner’s death if you are already age 73. The living spouse can also complete a spousal rollover or use the funds to create an IRA in their name later, as mentioned in the option above.

*Only applies until the minor reaches the age of the majority

2. All other beneficiaries

Non-spouse beneficiaries face more limitations in what they can do with the money in the retirement account they inherit. For instance, the IRS does not make any concession for a non-spouse beneficiary to roll assets from an inherited account into their own account. The beneficiary must contact the financial institution that holds the account and request that they rename it to identify them as the beneficiary. For instance, an account owned by Bob Jones and inherited by his daughter, Jane Smith, would be retitled, “Jane Smith, beneficiary of the Bob Jones IRA.”

Once the account ownership is established in the beneficiary’s name, the individual will choose how to take distributions. Under the SECURE Act passed in December 2019, beginning with the deaths of account holders in 2020 going forward, non-spouse beneficiaries are subject to a ten-year payout period. The inherited account must be zeroed out by the end of the tenth year following the original account holder’s death and the account closed. The account holder can receive any portion of the account in any year as long as he or she receives the full distribution by the end of the tenth year. The timeframe to receive the entire distribution is condensed, but beneficiaries do not have withdrawal requirements beyond this timeframe.

Additionally, when assuming control of an inherited retirement account, beneficiaries must take any annual required minimum distributions (RMDs) that are still due in the year of the original account holder’s death as the excise tax for failing to do so is 50% of the value of the RMD for that year. For instance, if the RMD on your inherited account is $10,000 and you fail to withdraw the money, you will pay a $5,000 excise tax to the IRS. In the case of multiple beneficiaries, there’s no stipulation on which beneficiary must fulfill the RMD that year, creating tax planning opportunities that will not be available in subsequent years. For instance, the beneficiary with the lower tax liability may choose to take the distribution, which could equal a larger benefit for all the heirs that year.

And one final reminder about inheriting IRAs: Ensure that your beneficiary information is up-to-date. Keeping this current is especially crucial for anyone who has been through a life change, such as marriage, a baby’s birth, divorce or a spouse’s death.

Learn more about the basics of beneficiaries.

Quick Recap:

• The way you receive the distributions of an inherited retirement account depends on your relationship with the original owner.
• Spouses and non-spouse beneficiaries have different options on how to receive their inherited accounts and should speak with an advisor to determine the best next steps.
• No matter a beneficiary’s age, beneficiaries must take the full distribution by the tenth year from the beneficiary account holder’s initial possession.

If you have further questions about your specific situation, contact a customer solutions specialist at 1-888-98-GUIDE (1-888-984-8433) Monday through Friday, between 7 a.m. and 6 p.m. CT.

This should not be considered tax advice. You should consult a tax professional to discuss your unique situation.