Inheriting an IRA

Requirements and Considerations

Dan Crimmins
Financial Adviser in Woodcliff Lake, NJ

Investing & Retiring Retirement IRA

Inheriting an IRA
February 10, 2016

Inheriting an IRA is the proverbial double-edged sword. On the one hand, you have acquired a new asset. On the other, you have lost a loved one and now face some important deadlines and potentially confusing options. Your choices and the ramifications depend on:

  • Type of IRA – Is the IRA a traditional or a Roth IRA? Withdrawals from Roth IRA's are not taxable income, since they were established with after-tax dollars – even the earnings are tax-free if the Roth IRA had been held for at least five years. However, traditional IRA withdrawals are considered taxable income.
  • Relationship to Decedent – Are you a spouse or a non-spousal beneficiary?
  • Age/Withdrawals of Decedent – How old was the decedent, and had he or she started taking minimum distributions yet?

Regardless of the above, if you do not take action by December 31st of the year after the year of the IRA owner's death, the IRS will make the choice for you. You will have to empty out the account within five years after the deadline. Failure to take required minimum distributions (RMDs) incurs a penalty of up to 50% of the money that should have been withdrawn.

Spouses have rollover options and can generally continue to make contributions to the IRA. Aside from cashing out, there are three paths for inheriting spouses:

  • Owner Designation – You assume ownership, and then determine the RMD as if you were the owner and take distributions – however, if you assume ownership in the year your spouse died, you must use his or her life expectancy, not yours.

    If the decedent was 70-½ or older, it is important to find out if they withdrew their mandatory distribution for that year. If not, you need the balance on Dec 31st of the prior year and the IRS Single Life Expectancy Table (instead of the table for IRA owners) to find the RMD you must take. In subsequent years, you use the same life expectancy minus one year.
  • Rollover – You can roll the IRA over into your own IRA, merge with an existing IRA, or within limitations, into a qualified employer plan.
  • Beneficiary Designation – If you are less than age 59-½, this saves you from having to pay a 10% early withdrawal penalty. You may then do a rollover after age 59-½ if you choose.
  • In this case, you have to set up a separate IRA account for your benefit in the decedent's name, and take the first distribution by the December 31st deadline. It must be clearly titled with the decedent's name, such as "John Q. Public, IRA, deceased (date), for benefit of Jane Q. Public, beneficiary".

For non-spouses, there are four basic options:

  • Lump Sum – You can cash out the IRA in a lump sum, with 100% of the funds included on your taxable income (unless it was a Roth IRA, then the principal is tax-free and taxes on earnings depend on the five-year holding rule).
  • Five-Year Cash-Out – You can empty the account within five years past the deadline of December 31st of the year after the owner's death (the IRS's default assumption). This assumes the IRA owner was younger than 70-½ and had not started taking minimum distributions yet.
  • Minimum Distributions with Your Life Expectancy – Called a "Stretch IRA,” this allows you to draw out the RMDs over your life expectancy. The title must be similar to the beneficiary designation example above.

    In this case and the following case, you use the IRS Single Life Expectancy Table to calculate the RMD.
  • Minimum Distributions, Other Life Expectancy – If there are multiple beneficiaries and you do not separate yours out in a separate account as in the above example, you will have to take out RMDs over the life expectancy of the oldest beneficiary of the IRA.

As a non-spouse beneficiary, you cannot make contributions to the IRA.

Check with the IRA's custodian to verify your options, or for complex issues like disclaiming the IRA, or inheritance through a trust. However, if you need help, you are probably better off seeking advice from financial advisors or estate planners than with the IRA custodian.

You have at least one year to act, so take your time, understand the situation, and make a plan. Just do not forget to act before that all-important December 31st date.

Let the free MoneyTips Retirement Planner help you calculate when you can retire without jeopardizing your lifestyle.

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