Inheriting an IRA: what you need to know

There’s never a downside to getting an inheritance, right? You get to splurge on that sailboat you’ve always wanted. Or pay off the debt that’s been your financial ball and chain. Best of all, with most inheritances, you won’t owe any taxes. You won’t even have to report them to the IRS.

There is one important exception, however: If you inherit an individual retirement account (IRA), any taxes on IRA distributions that would have been owed by the deceased will now owed by you. Without careful planning—reminder: your TIAA wealth management advisor can help—the distributions from an inherited IRA could even push you into a higher tax bracket. 

It used to be much easier to minimize the tax hit from inherited IRAs. Prior to 2020, nonspouse beneficiaries were obliged to start taking required minimum distributions (RMDs) no later than December 31 of the year following the death of the original account holder, but the rules thereafter were lenient. Nonspouse beneficiaries could spread out the distributions over their own life expectancies.

In other words, a 50-year-old who inherited a $100,000 IRA from his late father had 30 years to empty the account. This so-called “stretch” provision helped minimize the beneficiary’s yearly tax liability, while also allowing more of the inherited IRA money to grow tax deferred.

The SECURE Act, passed in 2019, eliminated the stretch provision for IRAs inherited after 2019.  Now nonspouse beneficiaries are generally required to empty inherited IRAs within 10 years. “Many of the people who inherit IRAs are adult children in their 50s,” said Jonathan Fishburn, a tax-and-estate specialist with TIAA’s wealth planning strategies group. “They’re in their prime earning years. So requiring them to take all the distributions over their next 10 years means requiring them to pay the taxes at the highest marginal rates.”

This is a high-class problem, of course. Few people would complain about any inheritance, even one with tax liabilities. That said, Fishburn offered five tips on how beneficiaries can smooth the inherited IRA process and minimize the tax hit.

• First step, set up an inherited IRA accountOpens pdf in your own name. You’ll need a copy of the decedent’s death certificate and information on the account you’ll be inheriting. Your TIAA wealth advisor can help you through the process. Once the new account is set up, you can then transfer the inherited funds from the original account.
• It matters what type of IRA you are inheriting. The tax rules only apply to traditional IRAs. If you inherit a Roth IRA, you won’t owe taxes on distributions, though you will still be required to empty the account within 10 years.
• The tax rules are more lenient for spouse beneficiaries. Spouses can roll over the inherited IRA into their personal IRA or put the money into a new, inherited IRA account. Either way, spouse beneficiaries are exempt from the 10-year rule. They can take the RMDs and pay the taxes gradually over their lifetimes instead of over 10 years.
• For most nonspouse beneficiaries, timing is everything. They must empty the inherited IRA account after 10 years, but they are not obligated to take a distribution every year (the IRS has yet to issue final rules on this—see below). The latter makes it easier to avoid an ill-timed distribution that could bump a beneficiary into a much higher tax bracket. “If you know you will be getting a big bonus in 2025, maybe you don’t take a distribution that year,” said Fishburn. “If you know you won’t be getting one, maybe you do.” Here's another scenario: Say you’re a 67-year-old about to retire, and you want to delay taking your Social Security or pension until age 70, when the monthly payments will be higher. It might make sense to use your inherited IRA money to bridge the gap between ages 68 and 70. For a newly retired couple with little other income coming in, a $120,000-a-year distribution from an inherited IRA would be taxed at only the 12% marginal rate (assuming the couple takes the standard deduction).

• You need to determine whether the original account holder had already started taking RMDs or had reached the age when he or she was supposed to have started taking them. Under either circumstance, a different 10-year rule may apply for nonspouse beneficiaries. According to preliminary guidance issued by the IRS in February 2022, nonspouse beneficiaries may be required to take a distribution every year, instead of being allowed to pick and choose.  They would be required to commence taking RMDs in the calendar year following the original IRA holder’s death and then continue taking RMDs annually until the account is fully emptied by the end of year 10.That said, IRS rules have yet to be finalized. Until they are, there won’t be penalties not taking annual RMDs, at least for years 2020 to 2023. Fishburn said he expects final rules to be issued later this year. Check with your TIAA wealth advisor for updates.