Last Updated on April 17, 2024 by Ben
You may be considering Fidelity Inherited IRA as a means of managing your inherited assets. They can provide tax-advantaged growth opportunities for heirs – but there are some things to be aware of when deciding if this type of account is right for you. The following article will discuss the basics of Fidelity Inherited IRAs so that you can decide whether or not this account type would work well with your financial situation.
Inherited IRA
When inheriting assets, you may be interested in continuing the potential for tax-advantaged growth of these assets while avoiding the impact of immediate income taxes.
Depending on your relationship with the person who originally had an account, different options are available. You should talk to an attorney before you do anything. You may want to consult with an advisor too. They will tell you what is best for you and what might happen if you take some other action that conflicts with the law.
Benefits of an Inherited IRA
Inherited IRAs are specifically planned for the beneficiaries—those who have inherited a workplace savings plan or IRA, such as a 401(k).
The benefits of an inherited IRA are many. You can continue the retirement account’s tax-deferred growth and avoid any immediate income taxes on distributions or withdrawals at whatever age you choose to take them from your savings. There are also no penalties for early withdrawal, which means that with careful planning now, you could enjoy a more financially secure future later.
RMD Rules for Inherited IRAs
When you inherit an IRA, it’s important to keep in mind that there are many IRS rules for required minimum distributions (RMDs). But be careful because your specific relationship with the deceased original owner will determine whether and when these RMDs apply.
When you inherit an IRA (traditional, rollover IRA, SEP-IRA, SIMPLE IRA), the Internal Revenue Service sets your RMDs in 3 categories: spouses, non-spouses, and entities. If you do not take the required minimum distribution from your account, you will be imposed a fine of 50% of the amount that should have been taken out.
If you get a Roth IRA, then the same rules apply—you have to take RMDs. However, if the assets have been in your account for five years or more, you can make tax-free withdrawals without penalty.
Spouses
If you have inherited an IRA from your spouse, you have the choice to either move it into your own IRA or transfer it to an inherited IRA. The RMD rules differ for each option, so consider which is best for you.
Move the Funds Into Your Own IRA
If you merge your assets into an IRA, then RMD rules will be applied. This option can be advantageous if:
- You are not yet 72 years old, but your spouse is. This means that you will be able to delay when you take distributions from your IRA until you become 72.
There are times when rolling transfer the assets to your own IRA may not be advantageous if:
- If you are under age 59½ and not eligible for withdrawals from your IRA due to the 10% early withdrawal penalty, you can instead take distributions from an inherited IRA.
Move the Funds Into an Inherited IRA
If you transfer your money into an inherited IRA, you draw RMDs based on how old they are. The amount of money you need to withdraw from a retirement account is based on your age and is recalculated each year. There are no penalties if you withdraw the money, so it can be good if you want to get the money right away.
Non Spouses
If you put your money into an inherited IRA or Roth IRA, your distribution requirements will be based on some factors. These include the date of their death.
If the account owner passed away before December 31, 2019, you have the option to take RMDs based on your age, using the IRS Single Life Expectancy Table.
In most cases, if the original account owner died after January 1, 2020, you will need to fully distribute your account within ten years of their death. Some people can get around the tax if they are an eligible designated beneficiary.
Eligible designated beneficiaries include a minor, disabled individual, or anyone not more than ten years younger. If you are an eligible beneficiary and meet the requirements to withdraw RMDs based on your age, these funds can be withdrawn in full without penalty.
Entities (Trusts, Charities, Estates)
If the beneficiary is a charity, entity, or non qualifying trust*, and the owner was still living by April 1 of the year in which the account holder reached age 72, distributions would (most likely) be based on a Single Life Expectancy. If the owner is younger than 72, they must distribute all the money in their IRA by December 31 of the 5th year after they die.
You need to talk to a trusted tax advisor. They can tell you if there is any way for the trust to get an exemption.
Inheriting an IRA From Your Spouse: What You Need to Know
Roll Over the Money Into A New or Existing IRA in Your Own Name
You have the privilege of transferring your deceased spouse’s IRA into an individual account in your name for the purpose of avoiding immediate taxation as the surviving spouse. If you do not need to take money from your spouse’s IRA and want to keep the money in a tax-advantaged account, this may be a good choice. If you are not 72, but your spouse was, you can take the death benefit distributions when you are 72.
If you are below age 59½ and need to access some or all of the assets from a traditional IRA, then your penalty will be 10% if you roll them into an existing account.
If you select to roll over the inherited IRA assets into your own, you must still fulfill the required Minimum Retirement Distribution (RMD) requirements. This means you will have to withdraw a certain amount of money from your IRA, including any inherited assets.
Transfer the Assets to an Inherited IRA
Transferring assets to an inherited IRA may be the best option if you are under age 59½ and need to access your spouse’s retirement account now or before you have reached that age. You can withdraw funds from inherited IRAs before age 59½ without incurring the hefty 10% penalty you would face if you were withdrawing funds from a non-inherited IRA. If you’re before the age of 59½, consider transferring inherited assets into your IRA.
If your spouse had an IRA, then there are particular rules that apply to you as the account beneficiary’s spouse. The decision whether or not to begin taking out required minimum distributions depends on when you want access to the inheritance (a situation in which immediate income taxes may be a concern). If you were older than your spouse, this might be important.
Once you reach the age of 72, it may be advisable that you also transfer over any assets left to you into an IRA in order to merge everything so that one person is not heavily penalized by the IRS for having a high income.
Roll Over the IRA Funds into a New or Existing IRA and then Convert the Assets to a Roth IRA
If you don’t anticipate relying on RMDs from your spouse’s IRA to pay your living expenses, it may make sense to roll the assets over into an IRA in your name and then convert the assets into a Roth IRA. This assumes that the inherited IRA is not already a Roth IRA and it is traditional.
With a Roth IRA, your contributions are not tax-deductible. You do not need to pay taxes on withdrawals as long as you meet certain conditions. But, you will have to pay taxes on the amount of money converted from your traditional IRA into a Roth IRA.
Therefore, converting assets to a Roth IRA may make sense for people who anticipate being in a higher tax bracket in the future and have assets in a non-retirement account. They would pay any income taxes associated with Roth IRA contributions before investing. Ideally, the taxes you pay should come from things that are taxed. If they come from tax-deferred or tax-exempt assets, then it will be a problem.
Decline to Inherit All or Part of the Money
If you take this option, your IRA will be passed to the people that are named as the primary beneficiaries. If they don’t want it, it will go to the people named in your spouse’s will. It can go to grandchildren, relatives, or a trust.
When assets are directly transferred to children or grandchildren, the potential for tax-deferred growth is limited as IRAs must be emptied after ten years. A chronically ill or disabled person, a minor child of the account holder, or someone who is less than ten years younger than the account holder can still take their retirement money in small steps over a long time.
In some cases, disclaiming IRA assets is a smart estate-planning strategy — especially when your spouse’s estate was not properly set up to manage the potential income taxes on these funds. When you get assets from a spouse, they are not subject to taxes. But remember that when you die, then they will be part of the estate. Make sure to get advice from a tax professional or lawyer before deciding what to do with them.
Roll Over the Money Into A New or Existing IRA in Your Own Name
You have the privilege of transferring your deceased spouse’s IRA into an individual account in your name for the purpose of avoiding immediate taxation as the surviving spouse. If you do not need to take money from your spouse’s IRA and want to keep the money in a tax-advantaged account, this may be a good choice. If you are not 72, but your spouse was, you can take the death benefit distributions when you are 72.
If you are below age 59½ and need to access some or all of the assets from a traditional IRA, then your penalty will be 10% if you roll them into an existing account.
If you select to roll over the inherited IRA assets into your own, you must still fulfill the required Minimum Retirement Distribution (RMD) requirements. This means you will have to withdraw a certain amount of money from your IRA, including any inherited assets.
Transfer the Assets to an Inherited IRA
Transferring assets to an inherited IRA may be the best option if you are under age 59½ and need to access your spouse’s retirement account now or before you have reached that age. You can withdraw funds from inherited IRAs before age 59½ without incurring the hefty 10% penalty you would face if you were withdrawing funds from a non-inherited IRA. If you’re before the age of 59½, consider transferring inherited assets into your IRA.
If your spouse had an IRA, then there are particular rules that apply to you as the account beneficiary’s spouse. The decision whether or not to begin taking out required minimum distributions depends on when you want access to the inheritance (a situation in which immediate income taxes may be a concern). If you were older than your spouse, this might be important.
Once you reach the age of 72, it may be advisable that you also transfer over any assets left to you into an IRA in order to merge everything so that one person is not heavily penalized by the IRS for having a high income.
Roll Over the IRA Funds into a New or Existing IRA and then Convert the Assets to a Roth IRA
If you don’t anticipate relying on RMDs from your spouse’s IRA to pay your living expenses, it may make sense to roll the assets over into an IRA in your name and then convert the assets into a Roth IRA. This assumes that the inherited IRA is not already a Roth IRA and it is traditional.
With a Roth IRA, your contributions are not tax-deductible. You do not need to pay taxes on withdrawals as long as you meet certain conditions. But, you will have to pay taxes on the amount of money converted from your traditional IRA into a Roth IRA.
Therefore, converting assets to a Roth IRA may make sense for people who anticipate being in a higher tax bracket in the future and have assets in a non-retirement account. They would pay any income taxes associated with Roth IRA contributions before investing. Ideally, the taxes you pay should come from things that are taxed. If they come from tax-deferred or tax-exempt assets, then it will be a problem.
Decline to Inherit All or Part of the Money
If you take this option, your IRA will be passed to the people that are named as the primary beneficiaries. If they don’t want it, it will go to the people named in your spouse’s will. It can go to grandchildren, relatives, or a trust.
When assets are directly transferred to children or grandchildren, the potential for tax-deferred growth is limited as IRAs must be emptied after ten years. A chronically ill or disabled person, a minor child of the account holder, or someone who is less than ten years younger than the account holder can still take their retirement money in small steps over a long time.
In some cases, disclaiming IRA assets is a smart estate-planning strategy — especially when your spouse’s estate was not properly set up to manage the potential income taxes on these funds. When you get assets from a spouse, they are not subject to taxes. But remember that when you die, then they will be part of the estate. Make sure to get advice from a tax professional or lawyer before deciding what to do with them.
Inheriting IRAs From Another Than Your Spouse
Move the Assets to an Inherited IRA and Take RMDs
When a traditional IRA is transferred to an inherited account, you have the option of taking distributions according to IRS guidelines. You can take them based on when the original owner died or if they specified in their will how these funds are distributed.
Disclaim All or Part of the Assets
If you decline to receive all or part of the IRA assets that are rightfully yours, they will be distributed among your eligible beneficiaries. If there is no other beneficiary who can take them on their behalf, those funds may be forfeited in accordance with the custodian’s agreement.
Other Key Points to Remember
Determine whether you are recorded as someone’s beneficiary
It is always a sensitive topic to broach with loved ones, but knowing in advance that you are listed as a beneficiary can be helpful. As life events such as marriage and divorce occur, it’s important for an IRA owner to confirm that the beneficiaries on their account match up. Remember also, when thinking about your will or estate plan; remember how these designations supersede them–so feel free to make changes at any time.
Request a trustee-to-trustee transfer
When someone inherits IRAs, make sure they are able to transfer the money from one account to another. There is no alternative for a 60-day rollover when the beneficiary is not a spouse. If you get a check, the money will be taxed as regular income. It can’t go into an inherited IRA account that you have at another company or back into the inherited IRA that it came out of.
Distributions from an inherited IRA can be invested in other accounts
When you are taking your required minimum distribution (RMD) from an inherited IRA, you have to pay taxes on it. You will need to pay state and federal income taxes. Once you take the money, it is yours and not the other person’s anymore.
Commingling of inherited IRAs
When inheriting an IRA from different owners, you cannot combine them into a single inherited IRA. When it is the same original owner and type of account- IRAs, for example- you can merge those. Consult a tax advisor regarding your situation to see how to distribute rules will vary for entities such as trusts, estates, and charities.
Summary
If you’re fortunate enough to inherit an IRA, it can be a windfall. But as with any complicated financial decision, there are pitfalls and considerations that need to be taken into account. So before proceeding on your own, make sure you contact the right professional who will help answer all of your questions about how best to proceed with this opportunity.