Can an Inherited IRA Be Split Between Siblings?

The quick answer is, yes, an Inherited IRA can be split between siblings! The process involves creating individual Inherited IRA accounts for each sibling or maintaining joint ownership. Both options have unique rules and tax implications. In this article, we’ll explore how to effectively answer the title question, discuss tax considerations, and outline the steps to ensure compliance with IRS regulations.

Understanding Inherited IRAs

An Inherited IRA is a tax-advantaged retirement account received after the death of the original IRA owner, including a deceased person’s IRA. The beneficiaries of an inherited account can be:

• a spouse
• a relative
• a friend
• an entity such as an estate or trust

This type of account comes with distinct rules and benefits that differ from a regular individual retirement account, so understanding its specific characteristics is important for the original account owner.

Inherited IRAs can be in the form of a traditional or Roth IRA, each with its own set of rules and tax implications. A traditional IRA is funded with pretax dollars, and withdrawals are taxed as ordinary income. On the other hand, a Roth IRA is funded with after-tax dollars, and qualified withdrawals are generally tax free. Regardless of the tax treatment, an inherited IRA must be established in the name of the beneficiary, and non-spouse beneficiaries cannot make additional contributions.

Naming beneficiaries is the preferred method for bequeathing an IRA because:

• It allows the assets to skip the probate process, ensuring a smoother and quicker transition.
• Spouses have the option to roll over an Inherited IRA into their own retirement accounts, which can be beneficial for tax and distribution planning.
• Non-spouse beneficiaries, including siblings, must follow different rules and cannot simply take ownership of the IRA account.

The withdrawal rules for Inherited IRAs differ significantly from those of non-inherited IRAs. For instance, beneficiaries must begin taking required minimum distributions (RMDs) according to their age and the type of Inherited IRA. These differences highlight the need to understand specific rules to avoid tax penalties and comply with IRS regulations.

Sibling Inheritance Eligibility

When siblings inherit an IRA, they are considered an Eligible Designated Beneficiary under IRS regulations. This means that siblings can inherit an IRA and must follow specific rules regarding distributions and account management. However, not all siblings may qualify as eligible designated beneficiaries, depending on the specific criteria set by the IRS.

The SECURE Act has significantly impacted how and when beneficiaries, including siblings, must withdraw funds from Inherited IRAs. One of the key changes is the requirement for non-spouse beneficiaries to withdraw all funds from the IRA within a 10-year period following the original account owner’s death. This rule ensures that plan assets are distributed and taxed within a reasonable time-frame, preventing the account from becoming “essentially an eternal IRA.”

Complications can arise when multiple siblings inherit an IRA, as different distribution rules may apply depending on their designated beneficiary status. For example, if one sibling is significantly younger than the other(s), the life expectancy method for calculating required minimum distributions could vary. Understanding these nuances is vital for effectively managing an inherited IRA between siblings and ensuring compliance with the rules.

Options for Splitting an Inherited IRA Between Siblings

Siblings have two main options for how to split an Inherited IRA: joint ownership of the account or creating individual Inherited IRA accounts. Each method has its own set of advantages and potential drawbacks, so it’s important to consider which option best suits the family’s dynamics and financial goals.

Joint ownership allows siblings to share control and decision-making regarding the plan, which can simplify management. However, creating separate accounts for each sibling helps streamline asset management and ensures compliance with IRS regulations.

Let’s delve deeper into these two options to understand their respective benefits and challenges.

Joint Ownership of an Inherited IRA

Joint ownership of an Inherited IRA means that siblings share control and decision-making responsibilities for the account. This can be beneficial in terms of collaboration, as it allows siblings to work together on investment decisions and withdrawals. Joint ownership can foster a sense of unity and shared responsibility, which is especially important during a time of loss.

However, joint ownership can also lead to complications, especially regarding Required Minimum Distributions (RMDs). Each sibling must be informed and compliant with the distribution rules, which can become complex if their financial situations or tax brackets differ significantly. Additionally, if one sibling wishes to withdraw funds without the consent of the others, it could lead to disputes and complicate the account management.

While joint ownership can simplify some aspects of managing an Inherited IRA, it requires careful coordination and clear communication among siblings to simply assume ownership, avoid conflicts, and ensure compliance with IRS regulations.

Creating Individual Inherited IRA Accounts

Establishing individual Inherited IRA accounts for each sibling offers several benefits. This method allows each sibling to tailor their withdrawal strategies based on their unique financial needs and goals. It also streamlines asset management, as each sibling can independently manage their account without needing to coordinate with others, including multiple Inherited IRAs.

Separate accounts ensure compliance with IRS regulations, reducing the risk of tax penalties. The benefits include:

• Each sibling can manage their RMDs independently.
• Each sibling can handle their tax obligations independently.
• The overall process is simplified.
• Potential disputes are prevented.

While both joint ownership and individual Inherited IRA accounts have their pros and cons, the latter often provides greater flexibility and ease of management, making it a preferred choice for many families, particularly for the account owner’s benefit.

Tax Implications When Splitting an Inherited IRA

Understanding the tax implications is crucial when splitting an inherited IRA. Under the SECURE Act, non-spousal beneficiaries are required to withdraw all funds from an Inherited IRA within a 10-year period. Siblings must fully liquidate the inherited IRA by the end of the 10th year following the original account owner’s death.

If siblings opt for a lump sum withdrawal, they will incur ordinary income taxes based on their tax bracket. This can result in a significant tax liability, especially if the IRA balance is substantial. Therefore, it is often advisable to spread withdrawals over the decade to manage the tax burden more effectively and pay ordinary income taxes accordingly.

The tax implications of withdrawing from an Inherited traditional IRA are particularly important to consider, as these withdrawals are taxed as ordinary income. On the other hand, distributions from an inherited Roth IRA are generally tax free, provided the account has been open for at least five years. Understanding these differences can help beneficiaries make more informed decisions about their withdrawal strategies.

Given the complex rules and potential tax consequences, seeking professional advice is advised when dividing an Inherited IRA. A financial advisor can offer valuable insights on effective strategies to reduce tax impacts. Additionally, a tax professional ensures compliance with IRS regulations, especially regarding the IRA’s tax status.

Required Minimum Distributions for Siblings

To comply with IRS regulations regarding RMDs from an Inherited IRA, siblings must:

• Take required distributions from the Inherited IRA.
• Understand that these distributions are mandatory.
• Recognize that each distribution must be taxed as income.
• Begin taking distributions no later than December 31 of the year following the death of the account owner, according to the IRS RMD table.

If the original account holder did not take their RMD in the year of their death, the beneficiary is required to take that RMD by December 31 of that year. If there are multiple beneficiaries, they need to set up separate accounts by the end of the year following the original account owner’s death to avoid RMD calculations based on the oldest beneficiary.

For minor children inheriting an IRA, he or she must switch to the ten-year method once they reach 21 years of age. Understanding these rules is vital for ensuring compliance and avoiding tax penalties.

Strategies to Minimize Taxes on Inherited IRAs

Minimizing taxes on Inherited IRAs requires careful planning and strategic approaches. One effective approach is to avoid taking a lump sum withdrawal immediately, as this can result in a significant tax burden. Spreading withdrawals over the 10-year period can help beneficiaries manage their tax bracket more effectively and reduce overall tax impacts.

Converting a traditional (pretax) IRA to a Roth before inheritance can also lessen future tax implications for beneficiaries. While this strategy involves paying taxes upfront, it can provide substantial tax benefits in the long run, as distributions from a Roth IRA are generally without tax.

Consulting a financial advisor helps in developing a tax-efficient withdrawal strategy. A professional can help beneficiaries navigate the complex rules and optimize their tax outcomes, ensuring they make the most of their inherited IRA.

Special Considerations for Minor Children

Certain beneficiaries, like minor children or those close in age to the deceased, are exempt from the 10-year withdrawal rule under the SECURE Act. A minor beneficiary requires a custodian to manage the Inherited IRA until they reach majority age. Once they reach the age of majority, they must deplete the IRA within that 10-year period.

For minors in continuing education, the 10-year rule for withdrawals can be extended until they turn 26. Understanding these special considerations is essential for effectively managing an inherited IRA for minor beneficiaries and ensuring compliance with IRS regulations.

Summary

Yes, an Inherited IRA can be split between siblings, and doing so into separate accounts is often the most practical and tax-efficient approach. After the death of the original IRA owner, siblings who are non-spouse beneficiaries must follow IRS rules—especially those outlined in the SECURE Act—which require the entire account to be fully distributed within 10 years. Splitting the IRA into individual inherited accounts allows each sibling to manage their RMDs and tax responsibilities independently, reducing the potential for conflicts and simplifying compliance.

While siblings may choose to maintain joint ownership of the Inherited IRA, this option can complicate distribution timing, tax planning, and decision-making. Traditional IRA withdrawals are taxed as ordinary income, while Roth distributions are typically tax free if the account meets the five-year rule. To minimize tax burdens, it’s generally better to spread withdrawals across the 10-year window rather than taking a lump sum. Additionally, special rules apply for minor children and other eligible beneficiaries. Given the complexity of these rules, working with a financial or tax advisor is highly recommended to ensure proper management and avoid penalties.

Frequently Asked Questions