What are the rules regarding inherited IRAs? My sibling and I recently inherited our parent’s IRA, and we would like to know how to handle it properly.

Inheriting an IRA from a parent comes with a unique set of rules. Understanding the rules can help you make the most of the money you inherit and avoid an unpleasant surprise at tax time. Here are some key guidelines every beneficiary should understand.

Setting It Up

Many people assume they can roll an inherited IRA into their own IRA, but that is not allowed for most beneficiaries. If you inherit an IRA from a parent, sibling or anyone other than a spouse, you cannot treat the account as your own. Instead, your share must be transferred into a newly established inherited IRA, properly titled in the deceased owner’s name. For example, the account title would say, “John Smith, deceased, for the benefit of Jane Smith.”

If your parent named multiple beneficiaries, the IRA may be split into separate inherited accounts. This allows each beneficiary to manage withdrawals independently, as if they were the sole beneficiary.

You can open an inherited IRA at most banks or brokerage firms, although the simplest option is often to set it up with the firm that already holds your parent’s account.

The 10-Year Withdrawal Rule

Under the SECURE Act, signed into law in December 2019, most non-spouse beneficiaries must withdraw all the money from an inherited IRA by the end of the 10th year following the original IRA owner’s death. This rule applies if the owner died in 2020 or later.

If your parent had already begun taking required minimum distributions (RMDs), you must continue taking annual RMDs while also withdrawing the entire account within 10 years. If your parent had not yet started taking RMDs, annual withdrawals are not required as long as the entire IRA is withdrawn by the end of the 10-year period.

You may take withdrawals faster if you choose, but distributions from a traditional IRA are taxable as ordinary income in the year taken. Roth IRA withdrawals, however, are usually tax-free, provided the account has been open for at least five years.

If you fail to take an RMD or do not withdraw the sufficient amount, you will incur a penalty of 25% of the amount you were supposed to withdraw. The penalty will be reduced to 10% if the mistake is corrected within two years.

Exceptions to the Rule

Several types of beneficiaries are exempt from the 10-year rule, including a surviving spouse, a child under the age of 21, a disabled or chronically ill beneficiary or someone who is within 10 years of age of the original IRA owner. These beneficiaries may be allowed to stretch withdrawals over a longer period.

Minimize Your Taxes

While it may be appealing to withdraw the entire amount from an inherited IRA at once or to make substantial withdrawals over a short period, it is important to exercise caution. Such actions could result in significant tax liability. Withdrawals from a traditional IRA are typically subject to tax at your income tax rate.

For many heirs, spreading distributions over the 10-year period can help manage taxes and reduce the risk of being pushed into a higher tax bracket. Other strategies may make sense if your income fluctuates or you are nearing retirement.

To help navigate these decisions, consider working with a financial advisor. If you do not have one, you can find a financial planner through the National Association of Personal Financial Advisors at napfa.org.

Savvy Living is written by Jim Miller, a regular contributor to the NBC Today Show and author of "The Savvy Living” book. Any links in this article are offered as a service and there is no endorsement of any product. These articles are offered as a helpful and informative service to our friends and may not always reflect this organization’s official position on some topics. Jim invites you to send your senior questions to: Savvy Living, P.O. Box 5443, Norman, OK 73070.