By Lee Sherman
Inheriting an IRA can be a financial boon but in order to get the most from it, you’ll want to understand not only how one works but also how the rules for beneficiaries differ.
Depending on which flavor or IRA you’ve inherited, the rules vary. For example, with a Roth IRA, which has already been taxed, you aren’t penalized for taking out the money. But where the original owner wasn’t required to take a required minimum distribution (RMD) the beneficiary is.
Your first distribution must be taken by 12/31 of the year following the owner’s death. While you must start then, there are no limits to how much you are allowed to withdraw. You can even take it out all at once if you’d like.
If the original owner of the IRA was younger than 70½ when they died and you’ve failed to take any distributions, you’ll be subject to the five-year rule and you’ll be required to withdraw the entire amount in the IRA by 12/31 of the year of the fifth anniversary of the owner’s death.
What is an Inherited (with a Capital I) IRA?
These rules apply to a typical beneficiary. If you are the owner’s spouse and the sole beneficiary, you have more options on how to handle the IRA. Whatever the type of account (Traditional, Rollover SEP or SIMPLE IRA), you can opt to either transfer the funds to your own existing IRA (or open a new one) or you can transfer the assets into what’s called an Inherited IRA (note the capital I) in your name. Your assets will continue to grow tax-deferred. But remember that if you are under 59½ you’ll be subject to the same distribution rules as the original owner. That means you are most likely subject to the 10% early withdrawal penalty. For all intents and purposes, you are just taking over the original owner’s IRA and can do what you want with it, as long as you stay within the rules. You can even designate your own IRA beneficiary
With an Inherited IRA, you may be required to take an annual distribution or you may have to take out all of the money within a specified number of years. With this flavor of IRA, RMDs are mandatory and are taxed on each distribution. The distribution schedule is based on life expectancy (determined by your age in the calendar year following the year of death). You can postpone them until you reach age 72 or as of 12/31 or the year after your death (where they will become the responsibility of whoever you’ve designated as your beneficiary). An Inherited IRA can’t be rolled over into another kind of IRA and it can only be transferred between one custodian and another.
This article just scratches the surface when it comes to the different options available for how to handle an inherited (lower-case) IRA. As we’ve seen, the rules can vary depending on age, marital status, and the number of beneficiaries. As always, we’d recommend speaking to an estate planner or other financial advisor about your particular situation.
Lee Sherman is a contributing writer to MyPerfectFinancialAdvisor, the premier matchmaker between investors and advisors. Lee is an experienced journalist and editor with over 30 years of expertise with a significant history of writing in the personal finance and technology arenas.
