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.