An Inherited IRA is a retirement savings account opened by the beneficiary of a deceased owner’s Traditional, Roth, Rollover, SEP, or SIMPLE IRA to continue to grow inherited funds on a tax deferred basis for retirement. The owner of an inherited IRA will be required to take distributions which are determined by the following factors: a. the age of the original retirement account owner at the time of death; b. the type of retirement account inherited; c. the relationship of the beneficiary to the original retirement account owner; and d. the type of Inherited IRA opened by the beneficiary. The owner of an Inherited IRA cannot make additional contributions to the account.
What to Do When You Inherit an IRA
When most people learn they have inherited an IRA or 401k, it is at a time when they are grieving the loss of someone close to them. An inherited retirement account comes with deadlines and important decisions to be made. The person who named you beneficiary of their retirement account probably wanted you to use it wisely. Yet making decisions about how to handle your inheritance may be very stressful, especially if you have no experience with investing or never had a retirement account before.
If you recently inherited funds held in an IRA or an employer sponsored retirement plan such as a 401k, there are several steps you can take to ensure you prudently manage your inheritance:
First, read all paperwork or instructions provided by the custodian of the retirement account. Highlight any deadlines or dates by which you must take action and note them on your calendar. Complete any forms required to verify your status as a beneficiary and supply all requested documentation.
The second step is to learn about your options regarding the inherited assets. Most IRA and 401k custodians have a designated phone number for beneficiaries to call with questions. Use your first call to the custodian as an opportunity to get information and educate yourself about your options, without making a commitment about your decision. It is generally a good idea to avoid taking any final action regarding your inheritance during the first call. A sales representative of the custodian may try to persuade you to take certain actions to keep the funds invested with their firm. While you may ultimately decide to invest your inherited funds with the custodian, you are under no obligation to take action immediately, provided you take action prior to the expiration of any deadlines. When you contact the custodian, ask the representative to explain your options. Take notes so you can evaluate each option later.
After you understand your choices, the third step is to get advice from a trusted advisor. Whether you inherit $5,000 or $500,000, the money left to you in a retirement account could play an important role in your future financial security. If you are not an experienced investor, consult a certified financial planner or CPA. If you do not have an advisor, ask friends, relatives or colleagues for a referral. Meet with the advisor and ask for a recommendation about how to handle your inheritance based on your current circumstances and financial objectives. However, never let a financial advisor sell you something you are not sure about. If the advisor tries to persuade you to make an investment, ask the advisor how he or she is compensated. Do your research and take the time you need to make a good decision. See Questions to Ask Your Financial Planner for more information.
After receiving professional advice about your inheritance, it is time to make a decision. Contact the retirement account custodian and submit any required paperwork to carry out your decision within the applicable deadlines.
Inherited IRAs and Estate Planning
An estate planning guide with excellent coverage of IRAs, 401ks, and other retirement accounts is Die Smart: 11 Mistakes That Cost Your Family When You Die. This book explains how to maximize the tax deferred value of retirement accounts when planning your estate. It features information on the distribution rules that apply when a beneficiary inherits a retirement account. Die Smart: 11 Mistakes That Cost Your Family When You Die explains the rules applicable to both spousal and nonspousal beneficiaries of IRAs, 401ks, and other retirement accounts. In addition, this guide covers other essential issues that should be considered when making an estate plan.
Note: This page provides a summary of the general rules that apply when a beneficiary inherits an IRA. However, the federal and state laws applicable to retirement accounts change frequently. Inherited assets can increase your income and estate taxes. Only a tax advisor and estate planning lawyer licensed in your state can properly advise you regarding the distribution options available to you with an inherited retirement account.
Deadlines Apply When You Inherit a Retirement Account
If you inherit an IRA with other beneficiaries, you should open your own Inherited IRA to hold your share of the inherited funds no later than December 31 of the year following the original account owner’s date of death. If you fail to open a separate account within the required time frame, the required minimum distributions from the account, called RMDs, will be based on the life expectancy of the oldest beneficiary.
If the original account owner was already required to take RMDs at the time of his or her death, but the required minimum distribution was not taken during the year in which the original owner died, the beneficiary must withdraw the RMD by December 31 of the year of the original owner’s death. If the beneficiary fails to take this RMD, the beneficiary will owe a federal tax penalty in the amount of fifty percent of the RMD amount.
If You Inherited IRA From Spouse
If you are the beneficiary of an IRA from your deceased spouse, you have the following options:
1. Withdraw the funds in a lump sum distribution and pay applicable income taxes. This type of withdrawal may push you into a higher tax bracket.
2. Transfer the funds to an Inherited IRA. You can begin taking withdrawals immediately from the Inherited IRA or choose to only take the required minimum distributions or RMDs.
3. Roll over the inherited funds to your own existing IRA, or a new IRA in your name, and take only the RMDs based on your own life expectancy. Only a spousal beneficiary can roll the inherited funds into his or her own existing IRA. This may be the best option for a surviving spouse who wishes to keep the inherited funds growing tax deferred to the greatest extent possible. However, if you need to withdraw funds prior to age 59 ˝, you will pay a federal tax penalty unless an exception applies.
4. Disclaim the inherited funds, or a portion of them, within nine months of the death of your spouse so they will pass to the contingent beneficiaries or next beneficiaries in line to inherit them. If you do not need the funds and are concerned about income or estate taxes, this may be a good option, particularly if you want another named beneficiary to inherit.
If You Inherited IRA From NonSpouse
If you inherited a retirement account from a parent, other relative, friend or anyone other than your spouse, you have the following options as a NonSpousal Beneficiary:
1. Take a lump sum withdrawal of the inheritance, include the distribution amount in your annual gross income, and pay applicable taxes.
2. Roll over the inherited funds to an Inherited IRA and begin taking the required minimum distributions or RMDs based on IRS requirements. Note: A nonspouse beneficiary cannot roll the inherited funds into his or her own IRA in the beneficiary’s own name.
3. Disclaim the inheritance, or a portion of it, within nine months of the death of the original account owner, so it will pass to the contingent beneficiaries or next beneficiary in line to inherit. If you do not need the funds and are concerned about income or estate taxes, this may be a good option, especially if you want the funds to pass to the next beneficiary in line to inherit.
. This book explains how to maximize the tax deferred value of retirement accounts when planning your estate. It features information on the distribution rules that apply when a beneficiary inherits a retirement account.