When an owner of an individual retirement account (IRA) account passes away, there could be the possibility that it's split between siblings. There are a few ways this can transpire, and I'll detail how this process works in this article.
Typically you are given the option to either take ownership of the inherited ira, or you can even roll the inherited account into your personal IRA. When siblings are involved, there are even more options.
If you have an inherited ira split between siblings, the first thing to know is that you can withdraw funds in one fell swift. Additionally, you have the option to transfer the funds into an "inherited ira."
How you divide up the money is up to you and your sibling, unless there was a will outlining specific amounts for each.
Here is how the process works.
Inheriting an IRA Account
To back up a moment, an IRA is a retirement account that has numerous tax advantages for the individual account owner. This is different from another retirement account that most people get through an employer, called a 401(k.) An IRA can be opened by anyone, and in the case of a self-directed IRA, (like the one that would be necessary to hold precious metals as we discuss on this website) the account owner chooses where to invest the money.
An inherited ira comes with a different set of rules than most other retirement accounts, however. The tax status of the IRA account comes into play here more than anything. The advantage of a "pre-tax" portfolio provides the advantage of not paying taxes on the money invested, but rather taxes are only paid on the growth when it's time to make withdrawals at retirement age.
Required minimum distributions come into play (RMD's) when you reach the age of 72, or in some cases, age 73. You'll be required to start taking yearly withdrawals. Factors that will come into play and make every scenario unique include how much is in the account as well as your age.
When you inherit an IRA, the RMD's will remain constant with the account. You'll be required to pay taxes on the IRA when you take RMDs, and this was put in place by the government so that people don't use the funds of the original account holder and tie it up for decades, accruing gains and not paying taxes. The government wants their cut, and this is the way they make sure that happens versus the account being passed to multiple beneficiaries for decades or more.
Understanding Sibling Inherited IRA Rules
If you and one or more siblings inherit an IRA, the first thing you'll have to understand is that after the original account holder's death, you need to see if you and your siblings are "eligible designated beneficiaries." You'll qualify for this if anyone that was named by the account owner to receive proceeds from their portfolio. If you do, you'll avoid the long and expensive probate process that will certainly ensue. Trust me, having gone through this personally, this is something you want to avoid at all costs. Having a designated beneficiary (or in this case, multiple beneficiaries) for a traditional ira, or an inherited Roth Ira, eliminates the probate process.
By avoiding probate and the estate process, you'll inherit the account directly. Do know, however, that the IRA account will be used to pay any debts or claims the original account holder had, so if they owed money somewhere, part of that will be liquidated to satisfy those debts.
As of 2020, the Secure act classified beneficiaries as "eligible" which includes the spouse of the account holder, any children that aren't yet adults, and anyone with a disability that is no less than 10 years younger than the account owner.
It's important to know that adult children will not qualify as eligible designated beneficiaries for this inherited IRA.
What Happens When Adult Siblings Inherit an IRA?
As an adult sibling inheriting an IRA, you have two options.
The first option is transferring the IRA account into what's called an inherited ira. From here you can either jointly manage the account as siblings.
The second option is to divide the sum into multiple inherited IRA accounts so they can then be managed separately.
When the account is inherited, you must make the rollover by December 31 of the year in which it was inherited. Whether you decide to keep a joint account or divide the account into multiple accounts is up to you.
From the point you take ownership in either scenario, you have 10 years to withdraw the funds and pay taxes on any money held in the original account. By year 10 it must be fully liquidated.
Prior to the year 2022, there was uncertainty about heirs having to take RMDs from the inherited ira, but that has been clarified as of 2023.
Speak with a financial advisor prior to doing this, but the updated IRS rule states that you can withdraw more than the amount stated, with the caveat that all required minimum distributions must be done within 10 years based on the IRS RMD guidelines. Again, the financial advisor who managed the account will know this, so please consult with them.
What About Taking a Lump Sum Inheritance?
Siblings do have the option of taking the inherited ira and withdrawing the full value in case. In this case, you can divide the assets as you see fit. This is a penalty free move, but you will pay ordinary income taxes in this scenario. You'll want to discuss your tax burden with an advisor if you choose to take the lump sum.
This also means the account never gets to the inherited ira stage because you chose to take a withdrawal upfront. You'll be paying taxes that year and this satisfies you withdrawing it in accords to the 10 year rule.
What About Minor Children Siblings Inheriting a Retirement Account?
Being a minor and inheriting an IRA makes the situation a bit more complex.
The Secure Act changed how minors and beneficiaries of an inherited ira back in 2019. The main takeaway from the altered rules is that minor children are now allowed to wait a longer period of time before cashing out the inherited ira. In the past, it was supposed to be withdrawn within 10 years, however, with the modified structure minor children are allowed to wait until they reach the age of 18.
They also have the same ability as adults do in the respect that they are able to transfer the IRA into an inherited ira. At that point the minor siblings are able to make the required minimum distributions in accordance to the accounts value as well as their life expectancy. The money does come with consequences, however, so know that there will be a tax burden on the inherited ira.
This is where it gets a little complicated. The majority of eligible designated beneficiary will be able to get required minimum distributions coming from the inherited ira for the duration of their lives.
BUT, when it comes to minor children, the rules change.
Each state has different rules in terms of what defines the majority age, but all states are either 18, 19, or 21. Once that age of majority is reached, the 10 year rule comes into play once again. In easier terms, once the minor reaches 18, 19, or 21, the inherited ira must be fully liquidated within 10 years. and required minimum distributions must occur.
For this reason, most inherited ira accounts that go to multiple beneficiaries are split into multiple individual inherited ira accounts. Each child will then be able to have the age of majority individualized to their own account. According to inherited ira rules, once any beneficiary arrives at the legal age of majority in their state, the 10 year rule kicks in.
Preparing Your Estate to Benefit from an Inherited IRA
Estate planning will go a long way in helping you through any inheritance.
As you can see this is a complex process that has a lot of rules. You can mitigate a lot of the risk and make everything a much smoother transaction ahead of getting this inheritance by using an estate planner to make sure everything is set up to have clear cut beneficiaries. With your own IRA, whether it be a traditional ira or Roth IRA, it's important to think ahead and avoid probate court at all costs.
Here's my short list of tips in regards to preparing your estate for an inherited ira.
Know the Various Types of Beneficiaries
You'll operate under a different set of rules for inheriting an IRA depending on if you are en entity beneficiary, a spouse, or a non-spouse. While a spouse can inherit the IRA assets and use it as their own, non spouse beneficiaries must defer to a defined set of distribution rules.
Understand the SECURE Act
Follow this link for a full description of what the SECURE Act is as it modified the rules for every inherited ira. Especially if you classify as non spouse beneficiaries - you'll need to know that you are required to withdraw the full balance within ten years. You do NOT want to get a penalty for not following the rules.
Know Your Tax Obligations
Large distributions could potentially move your income taxes to a higher tax bracket. When you get an inherited ira, you will need to keep this in mind and plan your withdrawals in a way to avoid moving to a higher tax bracket. Consider your tax obligations by speaking with whomever files your taxes.
Know Your Financial Picture
Having a good grip on your tax implications if you are assuming an inherited ira is in your future will help you immensely. If you know you are a designated beneficiary to someone who may be ill or has a life expectancy that doesn't look good, knowing where you stand tax-wise every year can help you plan for both long and short term growth and required minimum distributions of the ira assets.
While there are many rules - especially with non spouse beneficiaries, there is a light at the end of the tunnel. Knowing what an inherited ira entails when you are a designated beneficiary of a traditional ira, Roth IRA, or any type of retirement asset an account holder is passing on to you can help you lessen stress and make the best situation financially out of the inherited ira.
In Summary
Whenever tax implications come into play, planning ahead is always best. If you are listed as a designated beneficiary to an account holder and will be splitting an inherited ira with any siblings after the account owner's death, knowing the information conveyed on this page is step one.
If you are going to receive ira funds or inherited assets and have siblings, connect with your tax advisor to make sure you understand the RMDs and timeline on sorting out the inherited ira.
About Tim Schmidt Sr.
Tim Schmidt is an Entrepreneur and Serial Investor. Since 2012 he's been an advocate of alternative investments using a Self Directed IRA. His work has been featured in Yahoo! Finance, USA Today, Business Insider, and Tech Times, among others.
