Did you just inherit an IRA and have no idea what to do next? You’re not alone. Every year, thousands of Americans become IRA beneficiaries and find themselves confused by tax jargon, strict IRS deadlines, and distribution rules that seem designed to trip you up.
One wrong move could cost you thousands in unnecessary taxes or penalties. In fact, we find that 7 out of 10 IRA beneficiaries make at least one costly mistake when handling their inheritance.
But here’s the good news: With the right knowledge, you can navigate these waters confidently and potentially save tens of thousands in taxes while honoring your loved one’s financial legacy.
This guide explains what you need to know as a designated beneficiary – whether you’re a spouse, child, or more distant relative of the deceased.
Today, you’ll learn:
- How to effectively manage an inherited IRA while complying with IRS regulations
- The latest rules under the SECURE Act that impact designated beneficiaries
- When to use different withdrawal strategies to minimize tax liability
- Beneficiary-specific distribution rules for spouses, non-spouses, and trusts
- Real-world case studies showing how beneficiaries successfully navigate IRA inheritance
What Is a Designated Beneficiary?
A designated beneficiary is the person or entity named in an Individual Retirement Account (IRA) or employer-sponsored retirement plan to receive the remaining funds upon the owner’s death.
Types of Beneficiaries:
- Eligible Designated Beneficiary (EDB): Includes spouses, minor children, disabled or chronically ill individuals, and beneficiaries not more than 10 years younger than the deceased.
- Non-Eligible Designated Beneficiary (NEDB): Includes most non-spouse individuals such as adult children, siblings, or unrelated persons.
- Non-Designated Beneficiary (NDB): Includes estates, trusts, and charities, which do not have a specific life expectancy for payout calculations.
The type of beneficiary determines how quickly the inherited IRA funds must be withdrawn and the tax treatment of those distributions.
Steps a Designated Beneficiary Must Take After an IRA Owner’s Death
1. Notify the IRA Custodian and Gather Documents
The first step in managing an inherited IRA is notifying the financial institution that holds the account.
Required documents include:
- A certified death certificate
- The IRA account details
- Legal proof of beneficiary designation
Most financial institutions require beneficiaries to submit this paperwork within 30 days of the account owner’s death. Some institutions may have additional requirements, so contact them directly for their specific process.
2. Determine the Type of IRA and Beneficiary Status
The rules for an inherited IRA depend on whether it is a:
- Traditional IRA – Taxed upon withdrawal, subject to required minimum distributions (RMDs).
- Roth IRA – Contributions are tax-free; distributions may be tax-free if held for at least five years.
Your beneficiary status will dictate withdrawal timelines and tax obligations. One client who inherited her father’s Traditional IRA discovered she had different options than her sister, who inherited his Roth IRA, leading to completely different tax consequences.
3. Decide How to Handle the Inherited IRA
Beneficiaries can choose from several options, depending on their relationship to the deceased and the type of IRA.
IRA Distribution Rules for a Designated Beneficiary
The SECURE Act of 2019 significantly changed the rules for withdrawing inherited IRA funds. Most non-spouse beneficiaries must withdraw the entire account balance within 10 years of the IRA owner’s death.
Withdrawal Options for Different Beneficiary Types
1. Spouse Beneficiary Options
A spouse has the most flexibility when inheriting an IRA:
- Roll Over the IRA – The surviving spouse can transfer the inherited IRA into their own retirement account.
- Open an Inherited IRA – Required minimum distributions (RMDs) may be delayed until the deceased has reached age 73.
- Withdraw Lump Sum – Subject to income tax for Traditional IRAs but tax-free for Roth IRAs.
2. Non-Spouse Beneficiary Options
Most non-spouse designated beneficiaries must withdraw the full IRA balance within 10 years, following these rules:
- No annual RMDs are required unless the deceased has already begun RMDs.
- The full withdrawal can be spread over 10 years to manage tax liabilities.
- Roth IRAs are subject to the same 10-year rule but remain tax-free if held for five years.
3. Minor Child Beneficiaries
- Can stretch distributions until they reach adulthood.
- At age 18 (or 26 if still in school), the 10-year withdrawal rule applies.
4. Non-Designated Beneficiary (Estates, Trusts, Charities)
- If the IRA owner died before age 73, the 5-year rule applies, meaning the entire balance must be withdrawn within 5 years.
- If the IRA owner dies after age 73, RMDs must continue based on the deceased’s life expectancy.
Tax Implications for an IRA Designated Beneficiary
Traditional IRA Taxation
Withdrawals are taxed as ordinary income, regardless of whether they’re taken by the original owner or a beneficiary. This can create significant tax burdens if large distributions are taken in a single year.
Spreading withdrawals over the 10-year period can help reduce tax burdens. For instance, a beneficiary in the 24% tax bracket who inherits a $500,000 IRA would pay $120,000 in taxes if withdrawn as a lump sum. By spreading withdrawals across 10 years at $50,000 annually, they might remain in a lower tax bracket, potentially saving thousands in taxes.
Roth IRA Taxation
Tax-free withdrawals if the account has been open for at least five years. The five-year holding period applies to each Roth IRA independently.
If the five-year requirement is not met, earnings may be taxed upon withdrawal. However, the original contributions can still be withdrawn tax-free.
Required Minimum Distributions (RMDs)
RMDs begin based on the beneficiary type and the IRA owner’s age at death. They represent the minimum amount that must be withdrawn from a retirement account each year.
Failing to take required withdrawals may result in IRS penalties of 25% on the amount not withdrawn, reduced to 10% if corrected in a timely manner. This penalty increased from 50% under the previous regulations.
Understanding these tax rules helps maximize the financial benefits of an inherited IRA while remaining compliant with IRS regulations.
| Factor | Impact on Traditional IRA | Impact on Roth IRA |
|---|---|---|
| Tax at Withdrawal | Taxed as ordinary income | Tax-free if held for at least five years |
| Penalty for Early Withdrawal | Before age 59½: 10% penalty, unless an exception applies | No penalty on contributions, but earnings may be taxed |
| Best Strategy for Beneficiaries | Spread distributions over 10 years to reduce tax burden | Delay withdrawals to maximize tax-free growth |
| Effect of Not Taking RMDs | 25% penalty on missed required withdrawals | RMDs not required for original account owner |
| Who Benefits Most? | Beneficiaries expecting lower future income tax rates | Those who want tax-free withdrawals in retirement |
Common Administrative Challenges for an IRA Designated Beneficiary
1. Locating the Correct Beneficiary Information
If a beneficiary designation was not updated, ex-spouses or deceased individuals may still be listed. This can create legal complications and delays in distributing assets.
IRAs default to the estate if no beneficiary is named, causing delays and potentially unfavorable tax treatment. In such cases, the probate court determines the rightful heirs, which can take months or even years.
2. Missing Required Minimum Distributions (RMDs)
If the IRA owner had already begun RMDs and they were not taken before death, the beneficiary may face IRS penalties. The beneficiary must take the deceased’s final RMD by December 31 of the year of death if it hadn’t already been taken.
3. Tax Consequences of Large Withdrawals
Taking a lump-sum distribution can trigger higher tax brackets and increase the total tax owed. For example, a beneficiary who inherits a $300,000 Traditional IRA might pay $70,000 in federal taxes with a lump-sum withdrawal versus $45,000 if spread over several years.
4. Disputes Between Multiple Beneficiaries
If multiple individuals inherit an IRA, distribution disputes can arise. These conflicts often occur when the IRA owner named multiple beneficiaries but didn’t specify the percentage each should receive.
Some states have community property laws that may affect spousal inheritance rights, regardless of the named beneficiary. These laws exist in Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.
Beneficiaries should work with our tax attorneys to handle these challenges effectively.
How to Maximize the Benefits of an Inherited IRA
1. Plan Distributions Strategically
Spreading withdrawals over the 10-year period can reduce tax burdens. Consider taking larger distributions in years with lower income and smaller ones in high-income years.
If you inherit a Roth IRA, delaying withdrawals can allow tax-free growth. Since Roth IRA distributions are tax-free, it often makes sense to withdraw from other taxable accounts first.
2. Review and Update Beneficiary Designations
Ensure the correct beneficiaries are named to avoid delays and legal disputes. Regularly reviewing and updating beneficiary designations after major life events (marriage, divorce, birth of children) prevents complications.
Consider adding contingent beneficiaries in case the primary beneficiary is unable to inherit. Without contingent beneficiaries, the IRA may default to the estate if the primary beneficiary dies before the account owner.
3. Seek Professional Tax and Legal Advice
Work with an estate attorney or our tax professionals to ensure compliance with IRA rules. Tax laws change frequently, and professional guidance ensures you have the most current information.
If the IRA is part of a trust, consult an expert to manage distributions properly. Trusts can provide added protection and control but introduce additional complexity to the distribution process.
What Happens When No Designated Beneficiary Is Named?
If an IRA owner passes away without naming a designated beneficiary, the inheritance process becomes more complicated. The funds in the IRA typically default to the estate, and the distribution rules depend on the deceased owner’s age at the time of death.
Rules for Estates as IRA Beneficiaries:
- If the IRA owner was under age 73 (before RMDs began): The entire balance must be withdrawn within five years.
- If the IRA owner was over age 73 (RMDs had begun): Distributions follow the deceased owner’s remaining life expectancy.
Since estate distributions are taxed at high rates, failing to name a designated beneficiary can result in higher tax liabilities and potential legal disputes.
IRA Trusts: How They Affect Designated Beneficiaries
Some IRA owners choose to leave their IRA to a trust rather than directly to an individual. This approach provides greater control over distributions but adds complexity.
Advantages of Naming a Trust as an IRA Beneficiary:
- Protects funds from creditors and legal disputes.
- Ensures controlled distributions for young or irresponsible beneficiaries.
- Provides tax-efficient wealth transfer strategies.
Disadvantages of IRA Trusts:
- Trusts often follow the 10-year distribution rule, limiting long-term tax benefits.
- Some trusts may be taxed at higher income tax rates.
- Complex IRS rules apply, requiring careful legal structuring.
A tax attorney or estate planner can help determine whether an IRA trust is the best option for inheritance planning.
Special Considerations for Charitable Beneficiaries
Some IRA owners name charities as designated beneficiaries, which can have significant tax advantages. Since charities are tax-exempt, they can receive IRA distributions without paying income taxes.
Benefits of Leaving an IRA to a Charity:
- Eliminates income taxes on IRA withdrawals.
- Reduces the size of the taxable estate, potentially lowering estate taxes.
- Supports charitable causes while maximizing financial efficiency.
If you plan to name a charity as a designated beneficiary, ensure the organization is a qualified 501(c)(3) nonprofit to receive tax benefits.
Frequently Asked Questions Around Designated Beneficiaries
What is a designated beneficiary?
A designated beneficiary is an individual named to receive benefits from assets like retirement accounts or life insurance policies upon the account holder’s death. This designation ensures that the specified assets transfer directly to the beneficiary, bypassing probate. 
Who can be named as a beneficiary?
You can name any person, trust, or entity as a beneficiary. It’s also possible to designate multiple beneficiaries and specify the percentage of the asset each should receive.  
What’s the difference between a primary and contingent beneficiary?
A primary beneficiary is the first in line to receive assets upon your death. A contingent beneficiary, also known as a secondary beneficiary, inherits the assets only if the primary beneficiary predeceases you or cannot be located. 
How often should I update my beneficiary designations?
It’s advisable to review and, if necessary, update your beneficiary designations regularly, especially after major life events such as marriage, divorce, the birth of a child, or the death of a previously named beneficiary. 
What happens if I don’t name a beneficiary?
If you don’t designate a beneficiary, the asset may go through probate, and the distribution will follow state laws or the terms outlined in your will, which could result in unintended recipients. 
Can I name a minor as a beneficiary?
Yes, you can name a minor as a beneficiary. However, since minors cannot legally manage significant assets, it’s often recommended to establish a trust or appoint a guardian to manage the assets until the minor reaches the age of majority. 
Can beneficiary designations be contested?
Yes, beneficiary designations can be contested, particularly if there are allegations of undue influence, fraud, or if the designations contradict legal agreements like divorce decrees. Legal proceedings may be necessary to resolve such disputes.
How Silver Tax Group Can Help IRA Beneficiaries
Managing an inherited IRA involves complex tax regulations and administrative hurdles. At Silver Tax Group, we provide:
- Tax planning strategies for beneficiaries to minimize tax liability
- IRA distribution guidance to ensure compliance with IRS rules
- Estate and inheritance tax consultation for large or complex IRA accounts
- Assistance with disputes between multiple beneficiaries
Whether you are a spouse, child, or non-designated beneficiary, our team can help navigate the process and ensure you receive your inheritance smoothly.
Understanding the rules for an IRA-designated beneficiary is critical to managing an inherited IRA effectively. Whether you are required to take distributions over 10 years, calculate RMDs, or minimize taxes, having a clear plan is essential.
Need assistance handling an inherited IRA? Contact Silver Tax Group today for expert guidance.
