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 simple process. In most cases, you can simply take ownership or even roll over the inherited account into your own IRA. In the case of siblings, if you inherited a parent’s IRA, you have several options. Most notably, you can withdraw the entire value up front or transfer the account to what’s called an “inherited IRA.” And how you share this money is at your discretion. This is how it works.
If you have questions about the details of your inheritance, consider speaking to a financial advisor.
Inheriting an IRA
An IRA is a form of tax-advantaged retirement account that is owned and controlled by an individual. This separates it 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 themselves.
As with all retirement accounts, the rules surrounding inheriting an IRA are more complicated than other types of investment portfolios. This is due to the tax status of an IRA. Like a 401(k), a traditional IRA is known as a pre-tax portfolio. This means that you do not pay taxes on the money you invest in this account. You only pay taxes on the growth of the account when you retire.
As a result, this status triggers the rule known as required minimum distributions (RMDs). Starting at age 72 or 73, you must start taking money out of your IRA every year. The exact amount depends on your age and how much is in the account. But the goal is to make sure you withdraw enough money to eventually pay taxes on this portfolio.
These RMDs travel with the bill. If you inherit an IRA, the government still wants someone to start taking distributions out of the account so that it generates tax income. In large part, this is to prevent essentially a perpetual IRA, one that continues to grow tax-free for decades and generations as families pass the bill on to each other.
Inheritance from brother or sister
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.”
An IRA beneficiary is one or more people named in the account to receive the portfolio upon the death of the account owner. This is by far the best way to leave an IRA because it skips the probate process.
The beneficiary inherits the account directly and does not have to go through the normal probate and probate process. Although it is 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, beginning in 2020, certain categories of beneficiaries will be considered “eligible designated beneficiaries.” This includes the account owner’s spouse, any minor children, disabled or chronically ill individuals, and anyone who is not more than 10 years younger than the account owner. Adult children, that is, children over the age of 18, do not qualify as eligible designated beneficiaries.
Inheritances can involve many tax and legal nuances. For professional advice, you can be matched with a fiduciary financial advisor for free.
Adult siblings
When adult siblings, meaning those over the local age of consent, inherit an IRA, they have two options. The siblings transfer the IRA into an inherited IRA. They can use one account that they jointly own. Or they can divide the IRA among multiple inherited IRA accounts that each sibling owns separately.
This rollover must occur by December 31 of the year the IRA was inherited. If the siblings choose to jointly own one account, they can determine the terms of ownership among themselves. If they divide the account among multiple inherited IRAs, the siblings, without instructions to the contrary, can divide the inherited IRA as they see fit.
Once the account is transferred, the siblings have 10 years to withdraw all the money in this account and pay taxes. By the end of this period, the account should be fully liquidated.
The IRS has issued new rules regarding what is known as the 10-year rule. Before 2022, there was some debate about whether heirs should take RMDs from their inherited IRA or if they could withdraw the full value of the account in the 10th year.
The Tax Authorities appear to have provided clarity on this issue. Starting in 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 required minimum distributions based on the IRS’s RMD table.
Lump sum inheritance
A corollary to the ten-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 result in any special penalty, but you will have to pay regular income tax on this money. That tax rate is determined based on your income for that year.
In this case, you would not transfer the account to an inherited IRA. You would simply do a full recording beforehand. This is considered a corollary to the 10-year rule because it meets the basic requirement that you must withdraw taxes and pay taxes on the entire value of the IRA within 10 years of inheritance.
Minor children, brothers and sisters
Minor children who have inherited an IRA have an additional option. Please note that while we are talking about the siblings taking action, in this case the financial transactions are managed by a surviving parent or a guardian.
Majority Benefits
The minor siblings, like adult siblings, can transfer the IRA to an inherited IRA. The minor siblings then take the RMDs based on their life expectancy and the value of the account. These benefits begin on December 31 of the year in which they inherited the account. And this money is taxed as income.
Most eligible designated beneficiaries can continue to receive RMDs from the inherited IRA for the rest of their lives. However, the rule is different for minor children.
Once a child reaches the age of majority, beginning at age 18, 19, or 21, depending on the state, the ten-year rule applies. This means they must withdraw all the money from their inherited IRA account within ten years of reaching majority ownership. And in the meantime, they should take the RMDs with them.
The ten-year rule is one reason why it is beneficial to split an IRA into multiple, individual, inherited IRA accounts. This rule applies once a beneficiary reaches the age of majority, which means it is based on the age of the eldest child.
For help interpreting laws, taxes, and RMDs surrounding inherited IRAs, consider speaking to a financial advisor.
In short
Splitting an inherited IRA between siblings is a technical process that involves taxes. Generally, the siblings can choose to take over their inheritance over the course of 10 years or all at once. But the terms may change depending on their specific circumstances.
Estate planning tips
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Whether you select beneficiaries from your own IRA or are an IRA beneficiary who may be an eligible designated beneficiary, you need current knowledge of IRS regulations and tax implications. That’s where a financial advisor can be crucial. Finding one doesn’t have to be difficult. SmartAsset’s free tool connects you to financial advisors in your area within five minutes. If you’re ready to be matched with local advisors who will help you achieve your financial goals, get started now.
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It’s not unusual to have both an IRA and a 401(k) in your name. Ultimately, using both types of accounts can only increase your chances of a comfortable retirement. Check out SmartAsset’s 401(k) calculator and employer 401(k) matching guide.
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Have an emergency fund on hand in case you encounter unexpected expenses. An emergency fund should be liquid – in an account that is not at risk of significant fluctuations like the stock market. The trade-off is that the value of liquid cash can be eroded by inflation. But with a high-interest account, you can earn compound interest. Compare savings accounts from these banks.
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