Dave Ramsey: What Are Your Options if You Inherit an IRA or 401(k)? (2024)

If a family member passes away and you inherit their IRA or 401(k), it can be challenging to determine how to proceed. The situation can be variable depending on your connection to the deceased. Radio host and finance consultant Dave Ramsey recently looked at your best choices for what to do with an inherited retirement account, as this can be a difficult time in an inheritor’s life. The popular finance expert shared what steps you can take when you inherit an IRA or 401(k):

1. Receive a Lump Sum Payment

The simplest and most common solution is to take all of the accumulated funds in the retirement account as a single payment so that you can move on. Anyone who inherits an IRA can choose a lump sum payment. You can go with the lump sum and avoid taking the 10% early withdrawal penalty. You can also immediately access these funds.

The bad news is that you’ll have to pay taxes on this money if it is in a tax-deferred account, like the traditional IRA or a traditional 401(k). You would also be missing out on any potential future growth in the funds. Due to this lump sum, you could also end up in a higher tax bracket.

According to Ramsey, a lump sum makes the most sense when paying down debt or building up an emergency fund. This financial windfall could help you speed up the process of paying down debt or building a healthy emergency fund.

If you’re in a financial position where you don’t need the funds immediately, you have other options.

2. Open an Inherited IRA Account

When someone in your life passes away and leaves your inheritance as an IRA or employer retirement plan, you can roll these funds into an inherited IRA account. This new account is opened under your name, with the money from the original account added. If you don’t need the funds immediately, then this option will give you a chance to continue growing the money, and you can spread out your tax bill.

If you want to withdraw funds from an inherited IRA without paying any penalties, you then have two options:

The Life Expectancy Method:

In this case, you divide the amount left in the original retirement account by how many years you’re expected to live for based on the IRS’s Life Expectancy Table. This method ideally works best for the people inheriting an IRA from a spouse. If the funds aren’t from a spouse, there are a few other exceptions for this method:

• The person from whom you inherited the funds died in 2019 or before this;
• You’re disabled;
• You’re not more than a decade younger than the deceased;
• You’re a minor child of the account holder.

If you don’t match any of these categories, then you’ll be responsible for withdrawing all of the funds in the inherited IRA in ten years.

The 5-Year or 10-Year Method:

You can withdraw as much money as you wish from your inherited IRA account at any time as long as all the funds are gone within the five- or ten-year period you agreed to. If all of the funds aren’t taken from the account within the time period, you’ll be dealing with hefty penalties on the remaining balance. It’s worth pointing out that if the account owner died in 2019 or before this year, you’ll have five years to withdraw the funds. For a death in 2020 or after, you’ll have 10 years to withdraw the funds.

3. Rollover the Funds Into Your Own IRA (The Spousal Transfer)

This final option will only be available to those who inherited an IRA from a spouse, known as the “spousal transfer.” This rule allows the surviving partner to transfer the funds in the account into their own existing IRA. When these funds get transferred into your existing IRA, they’ll be treated like the other money in your account.

What About Taxes on Withdrawals From An Inherited Account?

Taxes on an inherited retirement account get fairly complex. If you inherit a tax-deferred retirement account like a traditional IRA or a traditional 401(k), then you’ll have to pay taxes on withdrawals. The money you pull out of these accounts will be considered taxable income. As always, it’s essential that you work with a certified financial planner since numerous technical details about taxes and withdrawals must be considered.