Inheriting a Parent's IRA? Here's What You Need to Know

Losing a parent can be a huge blow, even if they lived a long and happy life. And dealing with a parent's estate after their passing can also be stressful.

Part of that stress could relate to managing your inheritance. While it's nice to get a windfall, certain assets may come with restrictive rules you need to follow.

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If you're inheriting a parent's IRA, it's important to understand the complexities involved so you don't incur an IRS penalty. Here's a rundown of what you need to know.

You may only have 10 years to empty out the account

If you're inheriting an IRA, you might think you can let that money sit and grow until you need it. But there are rules surrounding inherited IRAs, and one of them is the 10-year rule. It basically states that you have to withdraw all of the money from an inherited IRA within 10 years if you're an adult inheriting a parent's IRA.

Now you have options for managing your withdrawals. You could spread them out evenly over 10 years to minimize your tax hit. Or, you could wait for a lower-income year and take all of the money out at that point.

But it's not always easy to plan for a year of lower earnings. So your best bet may be to plan to take money out of that IRA in equal installments over that 10-year period.

Remember, though, money you withdraw from an inherited IRA does not have to be spent. If you don't need the money for anything specific, you could always put it into a taxable brokerage account.

Similarly, let's say you have kids who will likely attend college in the future. You could take your IRA withdrawals, pay your taxes on that money, and then contribute what's left to a 529 plan for your kids' education.

You may be subject to RMDs

The nice thing about Roth IRAs is that they aren't subject to required minimum distributions, or RMDs. But if you're inheriting a traditional IRA, you may be forced to deal with RMDs, depending on the age of your parent when they passed away.

If your parent passed away at an age when they were on the hook for RMDs, then you have to take annual RMDs, too. However, if your parent wasn't of RMD age when they passed, then you don't have to take RMDs. You do, however, still have to empty out that IRA within 10 years. That requirement doesn't go away.

Also, if you're responsible for taking RMDs, know that that won't necessarily result in you depleting the IRA balance in 10 years. Put another way, even if you take an RMD every year as you're supposed to, there may be money left over in that account you'll need to withdraw before the end of that 10-year period.

As is the case with spending down an inherited IRA per the 10-year rule, if you don't need to spend your RMDs year to year, don't. You'll still have to pay taxes on that money, but you can use your RMDs to save for other goals.

You may want to get help managing an inheritance

Whether you're inheriting a parent's IRA, house, or other assets, managing a windfall can be daunting. And you don't want to overlook key rules that could leave you with an IRS penalty on your hands.

That's why you may want to consult a financial advisor if you're inheriting money. They can help you not only figure out what to do with that inheritance, but also, loop you in on key rules you need to follow.

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