Inherited IRA

Inherited IRAs (Beneficiary IRAs) can be a powerful tool for preserving and growing the wealth left by a loved one. Account holders at Directed IRA can self-direct their Inherited IRAs into alternative investments like real estate, private companies, and more.

What is a Self-Directed Inherited IRA?

An Inherited IRA (aka, Beneficiary IRA) is a retirement account designed for individuals who have inherited an IRA from a spouse, parent, or other individual. Beneficiaries can use a Self-Directed Inherited IRA to extend the tax-deferred benefits of the IRA beyond the original account holder and invest in alternative assets like real estate, private equity, and private funds.

 

This concept was introduced under the provisions of the Employee Retirement Income Security Act of 1974 (ERISA), which sought to safeguard retirement savings for Americans. Over time, legislation refined the rules surrounding Inherited IRAs—creating distinct options for spousal and non-spousal beneficiaries to manage inherited funds while preserving their tax-advantaged growth.

 

An important note for self-directed inherited IRAs with non-liquid assets is that you need to be prepared to meet RMD requirements which may be a lump sum in 5 years, a lump sum in 10 years, payments over 10 years and then fully distributed, or the life expectancy method. Self-directed investors using inherited accounts should consult with their tax advisor as to RMD planning for the asset over time based on their situation.

 

Distribution Options

 

When you inherit an IRA, you have three options for accessing the funds. The “Life Expectancy Method” is the most popular as it lets you delay the withdrawal of funds as long as possible—allowing additional growth in the account before distribution.

 

  1. Lump-Sum Distribution: Withdraw the full IRA balance at once. There’s no 10% early withdrawal penalty (regardless of your age or the deceased owner’s age) but the withdrawal is fully taxable for Traditional IRAs. Roth IRA distributions are tax-free if certain conditions are met. However, taking a lump sum forfeits the account’s tax-deferred or tax-free growth, making it the least favorable option for taxes and long-term finances.

  2. 10-Year Rule or Life Expectancy Method (Stretch IRA): As of 2019, the Stretch IRA’s “Life Expectancy Method” has been replaced with a 10-Year Rule for IRAs. This update came via the SECURE Act and applies to accounts inherited in 2020 or later.

    a) Inherited in 2020 or later: Requires the entire IRA balance to be distributed within 10 years of the original owner’s death. There are no required minimum distributions (RMDs) during this period, allowing strategic withdrawals while maximizing tax-deferred (Traditional IRA) or tax-free (Roth IRA) growth.

    b) Inherited before 2020: Inherited IRAs received in 2019 or earlier can still use the original Stretch IRA rules, allowing distributions over the beneficiary’s lifetime. For example, a $100,000 IRA inherited at age 50 may require an RMD of about $3,000 annually, with the rest remaining invested. Traditional IRA distributions are taxable, while Roth IRA distributions stay tax-free. However, inherited Roth IRAs are subject to RMDs, unlike standard Roth IRAs.

  3. Five-Year Rule: This applies to all inherited Roth IRAs and Traditional IRAs if the account holder was under the RMD age (72) at death. Under this rule, there are no annual RMD requirements, but the entire balance must be withdrawn by December 31 of the fifth year after the owner’s death. Traditional IRA distributions are taxable, while Roth IRA distributions remain tax-free. This option offers some flexibility but sacrifices the growth potential of the 10-year or life expectancy methods.

How to Self-Direct an Inherited IRA

Open a Self-Directed Inherited IRA

• If you’ve inherited a Roth IRA, you’ll need to open an Inherited Roth IRA. If Traditional, an Inherited Traditional IRA. If you inherited a traditional 401(k) or a SEP IRA (traditional funds) those can be transferred to an Inherited Traditional IRA. Fill out a new account application or book a call if you have questions.

Transfer of Funds

• Our team facilitates a trustee-to-trustee transfer. This is a tax-free movement of funds directly from your existing IRA custodian to your new self-directed IRA custodian.

Invest Your Account

• Account holders at Directed IRA can invest in any asset allowed by law. This includes alternative assets like real estate, private funds, crypto, private equity, and more.

Pricing & Fee Schedules

Frequently Asked Questions

What are the taxes on distributions from an Inherited IRA?

Taxes on distributions from an Inherited IRA depend on the type of IRA and the beneficiary’s tax situation. It’s important to comply with IRS rules to avoid penalties, such as the 50% excise tax for failing to take RMDs when required.

 

  • Traditional Inherited IRA: Distributions are taxed as ordinary income. The amount withdrawn is added to the beneficiary’s taxable income for the year.
  • Roth Inherited IRA: Distributions are generally tax-free if the account was held for at least five years before the original owner’s death. If the five-year rule is not met, earnings withdrawn may be subject to income tax.
  • Non-Spouse Beneficiaries: Must follow the 10-Year Rule (distribute the entire account within 10 years). Or, if inherited in 2019 or earlier you can be take Required Minimum Distributions (RMDs) annually based on life expectancy. All distributions are subject to the above tax rules depending on whether the inherited funds are Roth or Traditional.
  • Spouse Beneficiaries: Have the option to do a spousal rollover which means the surviving spouse transfers the deceased spouse’s fund or assets to an IRA in the surviving spouse’s name. It is not an Inherited IRA it is simply an IRA (roth or traditional) in the surviving spouse’s name and subject to rules for distributions based on the surviving spouse’s age. This can allow for greater tax advantaged growth for younger surviving spouses in their 60’s or 70’s who may not want to withdraw the entire account within 10 years.

Yes, if you are the spouse of the original IRA owner, you can transfer the deceased spouse’s account and funds into your own IRA through a Spousal Rollover. This is the only scenario where inherited funds can be merged into an existing IRA. This approach allows you to treat the funds as if they were always in your IRA, enabling continued tax-deferred or tax-free growth based on the original account type.

 

1. Verify your eligibility as a spousal beneficiary.

2. Elect to treat the Inherited IRA as your own (open an Inherited IRA) or transfer the funds directly into an existing IRA (Spousal Rollover).

3. Follow IRS contribution and RMD rules as applicable to your personal account (learn more).

1. Notify the Current Custodian: Contact the custodian managing the original IRA account and inform them of your beneficiary status.

2. Provide Required Documentation: Submit a certified copy of the death certificate and any other forms requested by the custodian.

3. Open an Inherited IRA Account: Transfer the funds into your new Self-Directed Inherited IRA under your name, or for spousal beneficiaries wishing to do a spousal rollover into an IRA in the surviving spouse’s name

4. Follow Distribution Rules: Ensure compliance with IRS regulations, such as Required Minimum Distributions (RMDs) or the 10-year withdrawal rule.

To qualify for an Inherited IRA (Beneficiary IRA), you must be named as a beneficiary on the original account. The rules vary slightly based on your beneficiary status:

 

  • Spouse: May treat the account as their own or roll it into their existing IRA.
  • Non-Spouse: Can inherit the account but must follow the 10-year distribution rule.
  • Trusts and Entities: Eligible if appropriately structured as a designated beneficiary.

In 2019, under the Setting Every Community Up for Retirement Enhancement (SECURE) Act, legislation eliminated the “Stretch IRA” strategy, which previously allowed non-spousal beneficiaries to stretch required minimum distributions (RMDs) over their lifetime. Instead, non-spousal beneficiaries are now generally required to withdraw the entire balance of the inherited account within 10 years. These reforms aimed to accelerate federal tax revenue while encouraging broader accessibility to retirement funds. Learn more.

More Resources on Self-Directing Inherited IRAs

Beginner’s Guide: How to Self-Direct Your IRA

Directed IRA Webinars

Self-Directed IRA Summit

Directed IRA Podcast

Beginner's Guide:
How to Self-Direct Your IRA

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#1 Book
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