Whether you’re planning your estate or named in someone else’s will, it’s important to understand the rules for inherited CDs and IRAs.

Those with assets to pass on, as well as heirs need to understand what happens when money is inherited. Unless you know the basics, you could get hit with penalties and taxes you weren’t expecting. Here are five things you should know about inheriting money from CDs or IRAs (individual retirement accounts).

Inheriting money in a CD

When ownership of a CD is passed to an heir, the value of the CD (the deposit amount and interest earned through the date of death) is not subject to income tax. However, interest earned after the date of death does count as income for the heir.

Usually, an early CD withdrawal results in penalties. However, many financial institutions waive the penalty in the case of the CD holder’s death.

As the beneficiary of the CD, you can put it in your own name, cash it out or reinvest it in a new CD account.

Rules on inheriting an IRA

The way an inherited IRA is handled depends on if the heir is a spouse or non-spouse.

If you inherit an IRA from your spouse, you can treat it as your own by designating yourself the account owner or rolling it over into an IRA in your name.

If you inherit an IRA from someone other than spouse, you can’t treat it as your own. This generally means you can’t make contributions or rollover any money into or out of the inherited IRA.

Whether you’re a spouse or non-spouse, you may also opt to:

• Withdraw the money in a lump sum (which could produce a hefty income tax bill unless the funds are from a Roth IRA)
• Withdraw the funds over time
• Disclaim the inherited assets and allow them to pass to the next beneficiary

If you choose to withdraw the funds over time, certain rules apply. You can withdraw all of the money within five years if the IRA owner died in 2019 or earlier, or within 10 years if their death was in 2020 or later.

Get more details on the rules of inherited IRAs from the IRS.

Many heirs may not stretch inherited IRA withdrawals over life expectancy

The Secure Act of 2020 requires many beneficiaries to zero out their inherited IRA account within 10 years. Previously, they were allowed to stretch withdrawals out over their life expectancy. Beneficiaries will owe income taxes on the withdrawals.

Who’s not required to withdraw the assets within 10 years? The new rule allows spouses, disabled beneficiaries and some others to take distributions over their life expectancies.

The new withdrawal rule applies to accounts of benefactors who die in 2020 and beyond.

When you can make withdrawals from an inherited IRA

IRS rules allow you to withdraw or use your traditional IRA assets at any time. However, keep in mind that a 10% additional tax generally applies if you withdraw or use IRA assets before you reach age 59½. 

Know when taxes are applied for inherited IRA withdrawals

Income tax is sometimes owed on withdrawals from an inherited IRA. If the IRA is a tax-deferred fund, heirs will owe income taxes on withdrawals, However, if the inherited IRA is a Roth account, heirs will not owe income taxes on withdrawals.

As an heir, you won’t owe taxes on a tax-deferred IRA until you receive distributions from it.

Please keep in mind, this article is a broad overview; it’s best to consult with a knowledgeable financial or tax advisor about your individual situation. If you’d like to set up CD accounts or retirement savings accounts that name your loved ones as beneficiaries, give us call at 800-991-2221. 

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