What to Do With Inherited IRAs

Common questions are estate planning lawyers hear are in regard to inherited IRAs.

IRAs are usually among the largest assets inherited. These retirement accounts have been able to grow to such very large amounts because income taxes on the growth in the account are deferred until the owner begins to take distributions. (You may take distributions as early as age 59 1/2, but must take them at age 70 1/2).

Cash-Out Option: Anyone who inherits an IRA can cash it out and withdraw the full amount. But because income taxes must be paid on the full amount withdrawn, this is not usually the best choice.

Spouse IRAs: A surviving spouse who inherits an IRA from his/her deceased spouse can roll that IRA into a new IRA or merge it with an existing IRA. In either case, the account can continue to grow tax-deferred, and the surviving spouse can continue to make contributions to the IRA, until s/he must start take distributions at age 70 1/2.

If the IRA is rolled into a new IRA, the surviving spouse will be asked to name new beneficiaries. It is highly advantageous to name someone much younger (e.g., children and/or grandchildren) because future distributions to the beneficiaries will be based on their actual life expectancies. This allows the IRA to potentially stretch out for decades. In some cases, it may be advisable to make your Revocable Living Trust the beneficiary of your IRA.

Non-Spouse Options: If the original owner of the IRA died before taking distributions, a non-spouse beneficiary can establish a Beneficiary IRA and start taking distributions based on his/her own life expectancy, with the option to take a lump sum at any time. (Ask your financial adviser to describe the difference between the “life expectancy option,” and the “five year rule”).

If the original owner died after beginning to receive distributions, a non-spouse beneficiary must take a distribution equal to the owner’s required minimum distribution for the year he/she died if one had not yet been taken. In future years, distributions can be based on either the new owner’s life expectancy, or the original owner’s remaining life expectancy, whichever is longer.

The original owner’s name must be listed on the title, but the inheriting beneficiary will name new beneficiary(ies). A non-spouse beneficiary cannot roll an inherited IRA into his/her own IRA or make contributions to an inherited IRA. But when distributions are stretched out over a longer period of time, the tax payments are also stretched out. And by keeping more money in the IRA for as long as possible, the tax-deferred growth can be maximized…which will result in a much larger balance.

About the Author: Dustin MacFarlane, Esq.

California Licensed Attorney | Estate Planning Specialist

Dustin MacFarlane is the founder of California Probate and Trust, PC, with over 15 years of experience in estate planning, probate administration, and trust law. Licensed by the California State Bar, Dustin has helped thousands of California families protect their assets and plan for the future.

CA Bar License: Active | Practice Areas: Estate Planning, Probate, Trust Administration | Location: Granite Bay, CA

Why Estate Planning Matters in California

California has unique estate planning laws that differ significantly from other states. Without proper planning, your assets may not pass according to your wishes, and your family could face unnecessary probate court proceedings.

A comprehensive California estate plan typically includes:

• A revocable living trust to avoid probate
• Pour-over will as a safety net
• Advance health care directive
• Durable power of attorney for finances
• Beneficiary designations on retirement accounts and life insurance

How Trusts Work in California

California’s trust law (Probate Code Division 9) governs how trusts are created, administered, and terminated. Understanding these rules is essential for effective estate planning.

Key benefits of California trusts:

• Avoid probate: Assets in a properly funded trust bypass California’s lengthy probate process
• Privacy: Unlike wills (which become public in probate), trusts remain private
• Control: You maintain control during your lifetime and direct distribution after death
• Incapacity planning: Your successor trustee manages assets if you become incapacitated
• Tax planning: Trusts can help minimize estate and income taxes