Consider the following scenario: A beloved parent has recently passed away, and you are dealing with her estate. She had money in a traditional IRA or 401k, which she has bequeathed to you. Can you simply fold that money into your own retirement account? Today, for non-Roth IRAs, the answer is no. Prior to 2019, before the SECURE Act took effect, the proceeds could simply be folded into your own IRA.
This is called an inherited IRA or 401(k), and it is subject to specific rules about withdrawal. Of course, the reason is that the IRS wants to tax that inherited money, as it originally intended as part of your mom’s required minimum distributions. Unless she employed a Roth plan, where the money was invested after being taxed, the inherited money will now be subject to federal taxes. But not all at once.
The 10-Year Rule
The IRS has specific withdrawal rules and tax implications. For traditional IRA and 401(k) accounts that are inherited (from anyone other than a spouse), the proceeds must be liquidated within 10 years. In most cases, you will have to take required minimum distributions, based on IRS guidelines, to ensure the proceeds are removed within 10 years.
That 10-year timeline starts the year after the person passed away (e.g., if the parent died in 2025, the account must be emptied by December 31, 2035). If the inherited IRA/401(k) is from a spouse, the money can indeed be immediately folded into an existing retirement account, without additional tax implications.
However, even inherited Roth retirement accounts assets, in which no taxes are owed, must be entirely liquidated within 10 years.
Some Exceptions
We mentioned that spouses who inherited money from their partner’s account are exempt from the 10-year rule. Additionally, the minor child of the person who died, a beneficiary who is disabled or qualifies as chronically ill is also exempt. Finally, someone who is less than 10 years younger than the deceased (e.g., a sibling) is not subject to the 10-year rule.
What Will You Be Taxed?
Just as if you were beyond age 73 and began to withdraw money from your own traditional IRA or 401(k), you will be taxed on those inherited IRA withdrawals as if it was ordinary income. That means taking lump-sum distributions from the inherited retirement account can also put you into a higher tax bracket. Withdrawing the full amount of the inherited retirement account can be a very costly mistake. Therefore, most people benefit from spreading their withdrawals over the 10 years.
The tax implications of inherited retirement accounts should be carefully considered, with the assistance of a financial planner, like Isakov Planning Group. Your financial planner can also help with the required procedural steps, like formally opening an inherited IRA account (which is usually titled like, “John Smith IRA (deceased) FBO Jane Smith, Beneficiary”) and helping you understand what your required minimum distribution would be throughout the 10-year period.
if you have any questions about inherited retirement plans.