Strategic Wealth Partners was acquired by Kovitz Investment Group Partners, LLC ("Kovitz"), a registered investment adviser with the SEC on May 1, 2024. Strategic Wealth Partners is now a division of Kovitz and its registered investment adviser. Materials created prior to this date were created by Strategic Wealth Partners and are accurate as of the time of publishing.

Inheriting an IRA? Know the Withdrawal Rules

Losing a loved one can bring not only an emotional burden, but complicated financial responsibilities related to inherited assets. The rules can be complex and not the most user-friendly. If you are the beneficiary and inherit a traditional Individual Retirement Account (IRA) or a Roth IRA, what exactly are your options? This article will address several factors that will determine what you can do and must do with an inherited IRA.

New Rules – the SECURE Act  

The SECURE Act passed into law in December 2019 significantly changed some of the withdrawal strategies for inherited IRAs. The new rules affect inherited IRAs if the original IRA owner died on or after January 1, 2020.

The biggest change is the elimination of the so-called “stretch IRA” for most non-spouse beneficiaries – e.g., siblings, children, grandchildren, or close friends. With the stretch IRA, it was possible to take distributions over your life expectancy and thus minimize inherited IRA withdrawals in any given year. This strategy allowed non-spousal beneficiaries to shelter a large portion of the inherited IRA from taxes. The SECURE Act gets rid of the stretch provision for most beneficiaries.

Let’s review the inherited IRA options for both the surviving spouse and the non-spouse beneficiary.

Surviving Spouse

Transfer Inherited IRA Assets Directly to Your Traditional or Roth IRA

If you are a surviving spouse, the easiest option is to transfer assets from your spouse’s account to your own traditional or Roth IRA. When transferring assets to your own IRA, distribution rules are the same as if the assets had been yours in the first place. Therefore, if you roll the assets into a traditional IRA in your name, you’ll have to take your first required minimum distribution (RMD) by April 1st, following the calendar year in which you turn age 72. (Remember, the SECURE ACT changed the RMD age to 72 from 70 ½).  If you roll the assets into a Roth IRA, you will never be subject to RMDs, although doing so will entail paying taxes on the amount converted.

There is a caveat with this option if you are not at least age 59½ and plan to draw money out soon from the IRA: any withdrawals before age 59½ are subject to a 10% penalty tax. Therefore, if you need to withdraw funds from the account, it may be best to actually transfer the account to an inherited IRA.

Transfer Assets into an Inherited IRA

As a surviving spouse, you can also create a new inherited IRA account in your name. More specifically, the deceased spouse’s name must appear in the inherited IRA title, as well as the surviving spouse beneficiary designation. Though very similar to transferring IRA funds into your own account, this method avoids the 10% penalty tax for withdrawals before age 59½ (as mentioned above). If you choose this option, the RMD will depend on whether your spouse had reached age 72 yet. For example, if your spouse passed away at age 75, and you choose to roll over his or her assets into a traditional IRA, you must begin taking distributions from the account by December 31st of the year following your spouse’s death. These distributions will be calculated using your life expectancy factor.

Alternatively, if your spouse passed any time before age 72, you may have the option to defer RMDs until your spouse would have turned age 72. These distributions will be calculated using your spouse’s life expectancy factor, due December 31st each year.  This strategy can be especially helpful when the deceased spouse is younger than the surviving spouse.

Withdraw Inherited IRA Assets as a Lump-Sum

Your spouse who inherits your IRA can choose to withdraw the entire account balance at once. Let’s review two different scenarios:

  • Inherit a traditional IRA
  • Inherit a Roth IRA

If all the funds are held in a traditional IRA, then the lump sum would be taxed as ordinary income (which is also the same tax effect as converting the entire amount into a Roth IRA). If the withdrawal is large enough, this lump-sum may even move you into a higher tax bracket, which would subject you to paying higher income taxes on the transaction.

If the IRA in question is a Roth IRA, a lump-sum withdrawal will be tax-free so long as the mandatory five-year holding period (known as the “5-year rule”) has already been met. This rule dictates that five tax years must pass after the first contribution to a Roth IRA before the first distribution can be made without penalty. Therefore, it is important to verify that your spouse’s Roth IRA has been open for at least five years to avoid unexpected taxation on Roth IRA withdrawals.

Non-Spouse Beneficiary

As a non-spouse beneficiary, you cannot retitle the IRA in your own name. That benefit is only available for your surviving spouse. You can, however, transfer the account into a new inherited IRA account.

If the inherited traditional IRA is from anyone other than your deceased spouse, and the decedent died on or after January 1, 2020, the beneficiary is required to withdraw all assets from an inherited IRA by December 31 of the 10th year following the IRA owner’s death. Exceptions to the 10-year rule include payments made to an eligible designated beneficiary (a minor child of the account owner, a disabled or chronically ill beneficiary, and a beneficiary who is not more than 10 years younger than the original IRA owner). This new eligible beneficiary class is still allowed to stretch payments over their life expectancy if they chose.

Exactly how the new 10-year rule works is still unclear. The initial interpretation under the SECURE Act appeared straightforward. The inherited account would need to be emptied by the end of the 10-year period after the death; no distributions would be required in years one to nine.

However, IRS Publication 590-B indicates that the non-spouse beneficiary would be subject to RMDs each year for year one through nine, and then the IRA must be emptied by the end of the 10-year period. We’ll continue to monitor the rules closely and provide additional guidance once the IRS provides more clarity.

Roth IRA

Under the SECURE Act rules, only certain eligible beneficiaries are allowed to use the stretch option and take withdrawals over their respective lifetimes (as noted earlier). Anyone else inheriting a Roth IRA must distribute all the assets in the account within 10 years of the original owner’s death.

Lump-Sum Distribution

The lump-sum distribution is always an option for non-spouse beneficiaries, regardless of Roth vs. traditional IRA or the age of the deceased. Roth IRA accounts that have met the 5-year rule will enjoy tax-free distribution, while traditional IRAs will be subject to the normal income tax rates.

Selecting the best option when inheriting an IRA can be complicated and stressful. We encourage you to contact your advisor for a more thorough analysis and to discuss your personal situation.

This article contains general information that is not suitable for everyone. The information contained herein should not be constructed as personalized investment advice. Past performance is no guarantee of future results. Reading or utilizing this information does not create an advisory relationship. An advisory relationship can be established only after the following two events have been completed (1) our thorough review with you of all the relevant facts pertaining to a potential engagement; and (2) the execution of a Client Advisory Agreement. There is no guarantee that the views and opinions expressed in this article will come to pass.  Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security.

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