Like most assets, you can inherit an individual retirement account (IRA) after the owner’s death. And for spouses, inheriting an IRA is a relatively straightforward process. In most cases, you can assume ownership or even roll the inherited account over into your own IRA. In the case of siblings, you have several options if you have inherited a parent’s IRA. Most notably, you can either withdraw the full value upfront or transfer the account into what is called an “inherited IRA.” And how you share this money is at your discretion. Here’s how it works.
If you have questions surrounding the specifics of your inheritance, consider speaking with a financial advisor.
Inheriting an IRA
An IRA is a form of tax-advantaged retirement account owned and managed by an individual. This makes it separate from accounts like a 401(k), which are managed through your employer (if you have one). Anyone can open an IRA, and anyone can manage the account on their own.
As with all retirement accounts, the rules around inheriting an IRA are more complicated than with other forms of investment portfolios. This is because of an IRA’s tax status. Like a 401(k), a traditional IRA is known as a “pre-tax” portfolio. This means that you don’t pay taxes on the money you invest in this account. You only pay taxes on the account’s growth when you make withdrawals in retirement.
As a result, this status leads to the rule known as required minimum distributions (RMDs). Starting at age 72 or 73, you must start taking money out of your IRA yearly. The exact amount depends on your age and how much is in the account. But the purpose is to make sure you withdraw enough money to eventually pay taxes on this portfolio.
These RMDs travel with the account. If you inherit an IRA, the government will still want someone to begin taking distributions from the account so that it generates tax revenue. In large part, this is to prevent essentially an eternal IRA, one which simply continues to grow tax-free for decades and generations as families hand the account down one-to-another.
Understanding Sibling Inheritance
When you and your siblings inherit an IRA from your parents, the first question is whether you and your siblings qualify as “eligible designated beneficiaries.” A beneficiary to the IRA is one or more persons who have been named in the account to receive the portfolio after the account owner’s death. This is by far the preferred way of bequeathing an IRA as it skips over the probate process.
The beneficiary inherits the account directly rather than having to take it through the ordinary process of estate and probate. Although it’s important to note that in this case, the IRA is still considered part of the estate. So it can be liquidated and used to pay any debts or other obligations.
Under the SECURE Act, starting in 2020, certain categories of beneficiaries count as “eligible designated beneficiaries.” This includes the spouse of the account owner, any minor children, disabled or chronically ill individuals and anyone who is not more than 10 years younger than the account owner. Adult children, meaning any children over the age of 18, will not qualify as eligible designated beneficiaries.
What Happens When Adult Siblings Inherit an IRA?
When adult siblings, meaning that they are over their local age of majority, inherit an IRA, they have two options. The siblings transfer the IRA into an inherited IRA. They can either use a single account that they jointly own. Or they can distribute the IRA among multiple inherited IRA accounts that each sibling owns individually.
This rollover must occur by Dec. 31 of the year in which the IRA was inherited. If the siblings choose to jointly own a single account, they can decide the terms of ownership among themselves. If they divide the account among multiple inherited IRAs, absent instructions otherwise, the siblings can divide the inherited IRA as they see fit.
Once the account is rolled over, the siblings have 10 years to withdraw and pay taxes on all of the money within this account. The account must be fully liquidated by the end of this period.
The IRS has issued new regulations surrounding what’s known as the 10-year rule. Prior to 2022, there was some debate as to whether heirs had to take RMDs from their inherited IRA or if they could withdraw the full value of the account in the 10th year.
The IRS appears to have clarified this issue. Effective since 2023, you must take RMDs from an inherited IRA. You can withdraw more than this amount. And the account must be empty by the end of year 10. But you must take the required minimum distributions based on the IRS’ RMD table.
Lump Sum Inheritance
A corollary to the 10-year rule is that the siblings can withdraw the entire value of the IRA in cash and divide the assets among themselves. This will not incur a special penalty, however, you will have to pay ordinary income taxes on this money. That tax rate will be set based on your income for the year.
In this case, you would not roll the account over to an inherited IRA. You would simply make a full withdrawal up front. This is considered a corollary to the 10-year rule, as it satisfies the basic requirement that you must withdraw and pay taxes on the full value of the IRA within 10 years of inheriting it.
What Happens When Minor Children Siblings Inherit an IRA?
When minor children inherit an IRA, the process can be complex, and understanding the rules is crucial for effective management. The SECURE Act, passed in 2019, significantly altered the landscape for inherited IRAs, particularly affecting how beneficiaries, including minor children, must handle these accounts.
Under the new regulations, most beneficiaries are required to withdraw the entire balance of the inherited IRA within ten years. However, minor children have a unique status that allows them to stretch distributions over a longer period, at least until they reach the age of majority.
Age of Majority Distributions
The minor siblings, like adult siblings, can transfer the IRA into an inherited IRA. The minor siblings will then take the RMDs based on their life expectancy and the account’s value. Those distributions will begin on Dec. 31 of the year in which they inherited the account. And this money is taxed as income.
Most eligible designated beneficiaries can continue receiving RMDs from the inherited IRA for the rest of their life. However, the rule is different for minor children.
Once any child reaches the age of majority, starting at age 18, 19 or 21, depending on the state, the 10-year rule applies. This means that they must withdraw all of the money from their inherited IRA account within 10 years of achieving a majority. And they must take the RMDs in the meantime.
The 10-year rule is one reason why it’s advantageous to split an IRA into multiple, individual inherited IRA accounts. This rule applies as soon as any beneficiary reaches the age of majority, meaning it is based on the age of the oldest child.
Estate Planning Tips for Inheriting an IRA
Inheriting an IRA can be a complex process, but with the right estate planning tips, you can navigate it smoothly and make the most of your inheritance. Whether you’re a spouse, child, or another beneficiary, understanding the rules and options available to you is crucial. Here are some essential estate planning tips to consider when inheriting an IRA.
- Understand the different types of beneficiaries: The rules for inheriting an IRA vary depending on whether you are a spouse, non-spouse, or entity beneficiary. Spouses have the option to treat the IRA as their own, while non-spouse beneficiaries must follow specific distribution rules. Knowing your beneficiary type helps you plan the best course of action.
- Familiarize yourself with the SECURE Act: The SECURE Act, enacted in 2019, changed the distribution rules for inherited IRAs, particularly for non-spouse beneficiaries. Most non-spouse beneficiaries must now withdraw the entire balance within ten years. Understanding these changes is vital to avoid penalties and optimize tax strategies.
- Consider tax implications: Inherited IRAs can have significant tax implications, especially if large distributions push you into a higher tax bracket. Planning your withdrawals strategically can help minimize taxes. Consulting with a tax advisor can provide personalized strategies to manage your tax liability effectively.
- Evaluate your financial goals: Aligning your inherited IRA with your financial goals can maximize its benefits. Whether you aim for long-term growth, immediate income, or a combination of both, understanding your financial objectives will guide your distribution decisions. This alignment ensures that the inheritance supports your broader financial plan.
Inheriting an IRA comes with responsibilities and opportunities. By understanding the rules, considering tax implications, and aligning with your financial goals, you can make informed decisions that benefit your financial future. Seeking professional guidance can further enhance your strategy, ensuring you make the most of your inheritance.
Bottom Line
Splitting an inherited IRA between siblings is a technical process that involves taxes. It’s important to be aware of the required minimum distributions (RMDs) that must be taken from the inherited IRA, as these can vary based on the age of the original account holder and the beneficiaries. Consulting with a financial advisor or tax professional can provide valuable guidance to ensure compliance with IRS regulations and optimize the financial benefits for each sibling.
Tips on Estate Planning
- Whether you are selecting beneficiaries of your own IRA or are an IRA beneficiary who may potentially be an eligible designated beneficiary, you need up-to-date knowledge of IRS regulations and tax consequences. That’s where a financial advisor can be vital. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- It’s not unusual to have both an IRA and a 401(k) to your name. In the end, utilizing both types of accounts can only improve your chances of reaching a comfortable retirement. Check out SmartAsset’s 401(k) calculator and guide to employer 401(k) matching.
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