TABLE OF CONTENTS
- What is an inherited IRA?
- Types of Inherited IRAs
- Traditional vs Roth Inherited IRAs
- Spousal vs Non-Spousal Inherited IRAs
- Tax Rules For Inherited IRAs
- Five Year Rule
- Life Expectancy Distributions
- Inherited IRA Cheat Sheet
- How do I roll over my inherited IRA?
- Special Considerations
What is an inherited IRA?
An inherited IRA—also known as a beneficiary IRA—is an individual retirement account with tax advantages that’s left to one or more beneficiaries when the original owner of an IRA or employer-sponsored retirement plan passes away. Inherited IRAs can be left to anyone, including spouses, relatives, estates, and trusts.
Types of Inherited IRAs
Inherited IRAs have four possible types, as there are two tax-status types and two beneficiary types, each of which determine the treatment they will receive by the IRS and the rules they must follow: Traditional vs Roth, and Spousal vs Non-spousal.
Tax-Status: Traditional vs Roth Inherited IRAs
- Inherited Traditional IRAs: All pre-tax accounts left to beneficiaries can be rolled into an inherited Traditional IRA. This includes SEP IRAs, Simple IRAs, Rollover IRAs, and Traditional 401(k)s, among others. Owners of an inherited Traditional IRA must include in their gross income any taxable distributions they receive from that IRA. Some inherited accounts have previously been funded with after-tax contributions, which means that a portion of the distribution may be non-taxable.
- Inherited Roth IRAs: All Roth type accounts left to beneficiaries can be rolled into an inherited Roth IRA. This includes Roth 401(k)s, Roth 403(b)s, and Roth IRAs, among others. Some pre-tax employer accounts, such as a Traditional 401(k), are able to be rolled over directly into an inherited Roth IRA as a conversion, which would be a taxable event. If those accounts have already been rolled over to an inherited Traditional IRA, conversions are no longer possible because inherited Traditional IRAs are not allowed to be converted to inherited Roth IRAs for non-spouse beneficiaries.
Beneficiary Type: Spousal vs Non-Spousal Inherited IRAs
- Spousal Inherited IRAs: Inherited directly from a legal spouse, and have more options available for what the beneficiary can choose to do with it. Spousal IRAs are the only inherited IRAs that can be subsequently rolled into a non-inherited/regular IRA.
- Non-spousal Inherited IRAs: Inherited from someone other than a legal spouse. Like the original owner, you generally won’t owe tax on the assets in the IRA until you receive distributions from it. Inherited IRA owners must begin receiving distributions from the IRA under the rules for distributions that apply to beneficiaries.
Tax Rules For Inherited IRAs
Please note that this is not an exhaustive list and Betterment is not licensed to give tax advice. For the best information for your individual circumstances, please consult a qualified tax professional.
Beneficiaries cannot make any contributions or roll over any new funds into an inherited IRA.
If a spouse inherits an IRA and makes a contribution into it, the IRA loses its inherited status, and is now viewed by the IRS as a regular IRA that’s owned by the beneficiary.
All inherited IRAs have mandatory distributions, either in the current year or at some point in the future. You read that right. Inherited IRAs (Roth or Traditional, spousal or non-spousal) all have mandatory distributions, which are reflected in the chart below.
For spousal inherited IRAs, the IRS views it as your own if you don’t take the required minimum distribution for a calendar year as the beneficiary. This effectively means the IRA is now yours as a regular IRA without an inherited status.
The rules differ for what sorts of mandatory distributions must be taken from an inherited IRA, and these are determined by whether or not it’s a Traditional or Roth, as well as whether it’s spousal or non-spousal. A brief explanation of the rules can be found here: IRS RMD Chart.
For IRAs that remain as an inherited IRA—meaning a spouse has not chosen to treat it as their own—there are two options for distributions. Each of these options is exempt from the 10% early withdrawal penalty that is usually assessed by the IRS on withdrawals before age 59 ½. The early withdrawal penalty applies if you treat the IRA as your own.
Five Year Rule: Requires that the account be completely distributed by the end of the 5th year after the original owner’s death. No distributions are required before that point. This distribution type is only available for Inherited Traditional IRAs if the original account owner died before turning 70 ½.
Life Expectancy Distributions: Requires that you withdraw a certain amount each year according to IRS calculations. The rules for this vary by account type and the age of the original IRA owner on the date they passed away.
Beneficiaries cannot do a rollover from an inherited IRA. However, beneficiaries are able to make a trustee-to-trustee transfer from one custodian to another. This can only be done if the new IRA is set up and maintained in the name of the deceased IRA owner for the benefit of the beneficiary.
We have broken down some of the primary considerations for the different account types in the figure below, but please note that this is not an exhaustive list and Betterment is not licensed to give tax advice. For the best information for your individual circumstances, please consult a qualified tax professional.
Inherited IRA Cheat Sheet
Tax-Deferred aka Pre-Tax
|Spousal (inherited from a spouse)||
|Non-Spousal (inherited from anyone that was not a legal spouse)||
How to Roll Over an Inherited IRA
You are able to transfer an inherited retirement plan to Betterment through a process called a trustee-to-trustee transfer. Your current provider will send us a check directly, for your benefit. We will assist you throughout the whole transfer and set up process, so if you’d like to get started, please email us at email@example.com.
In order to create your inherited IRA at Betterment, and generate the necessary transfer paperwork, include the following information in your email:
- Name of current provider
- Type of IRA (Traditional or Roth)
- The IRA account number at the current provider
- Indicate “full” or partial transfer, and exact amount to transfer if partial
- Name of original IRA account holder
- Since we are opening a new account type, you’ll need to review our Customer Agreements and give consent by writing “I agree to the customer agreements”
Once we have this information, we can set up an inherited IRA and draft authorization letters for the transfer.
Though the IRS allows it, estates, trusts, and charities cannot currently be owners of an inherited ira at Betterment.
There are few things to keep in mind when rolling over an inherited IRA to Betterment, as well as to other institutions.
Required Minimum Distributions: At this time, Betterment does not automatically calculate RMDs for inherited IRAs, though we hope to provide this feature in the future. For customers who are on our Premium plan, our team of CERTIFIED FINANCIAL PLANNER® professionals can help you calculate this during one of your scheduled advice calls.
Otherwise, you will need to calculate your RMD by reviewing the “IRA beneficiaries” section of IRS Publication 590-B. We will provide the fair market value of your IRA by December 31st of every year with your tax forms, and you can calculate your RMD using this amount.
No Indirect Rollovers: Non-spouses are not permitted to do an indirect rollover of an inherited IRA under any circumstances. The IRS does allow indirect rollovers of spousal IRAs, however, Betterment recommends adhering to the direct trustee-to-trustee transfer process to avoid any errors—which could cause preventable tax consequences.
Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a qualified tax professional.