You Inherited an IRA...Now What?

Posted: Updated:
(Image courtesy of Bedel Financial Consulting Inc.) (Image courtesy of Bedel Financial Consulting Inc.)

Inheriting an IRA can be a blessing.  Dealing with the IRS distribution rules can be a headache. Understanding your options will allow you to avoid unnecessary penalties.

If you are the beneficiary of an Individual Retirement Account (IRA) and the IRA owner passes away, what are your options?  In order to avoid immediate payment of income tax, you need to understand the rules and meet the time schedule required by the IRS.

Non-spouse as the Beneficiary

If you inherit the IRA of your parent, other relative, or friend, the account becomes designated as an Inherited IRA.  The title of the account generally includes the names of the deceased owner and the beneficiary, such as "John Doe Inherited IRA for the benefit of Jane Smith."

Important to note: You cannot combine the Inherited IRA with any other IRAs that you own.  Likewise, you cannot make contributions to the Inherited IRA. 

You are required to distribute funds from your Inherited IRA based on one of three options.  Even though you may be younger than age 59 ½ years, there is no penalty for “early distributions” as would be the case for an owner of a traditional IRA.  Any funds received from the Inherited IRA, less the allowance for after-tax contributions by the owner, are subject to income tax. 

Lump-sum Now.  You can take 100% of the funds immediately.  The taxable amount is included on your tax return for that year.

Distribute Any Amount over Five Years.  You can receive any amount you would like during the period ending on December 31 of the year containing the fifth anniversary of the death of the account owner.  For example, if the owner of the IRA died on June 1, 2017, all the funds must be distributed prior to December 31, 2022.  Using this method, you can spread the distributions over as many as six tax years or you can decide to withdrawal the entire amount in the last year of the period.

Distribute over Lifetime. You can spread the distributions over your life expectancy.  This allows the funds in the account to continue to accumulate on a tax-deferred basis for the maximum time period. To take advantage of this method, you must take your first distribution by December 31 of the year following the year of the account owner’s death. Per our example above, if the owner died on June 1, 2017, the first distribution must be received by December 31, 2018. Using the appropriate factor provided by an IRS distribution table, calculate the amount you must withdraw. You can always withdraw more than the minimum.  However, on any required amount that is not withdrawn, you will be subject to a 50% penalty.

Spouse as the Beneficiary

If you inherit the IRA of your spouse, you can treat the IRA as if it were your own.  Treating the IRA as your own allows you to continue the tax deferral of the existing funds and to withdraw minimum distributions based on your age.  If you qualify, you can make annual contributions to the IRA or convert the IRA to a Roth IRA. You can handle the account in two ways:

  • Maintain the account as is and simply change the designated owner to yourself.  The rules for distribution are then based on your age and not the age of your deceased spouse.  This means that you cannot withdraw money from the IRA until your age of 59 ½ years without paying the 10% penalty.  Likewise, at your age of 70 ½ years you are required to withdraw the minimum distribution amount.
  • Instead of maintaining the existing account, your second choice is to roll the funds of the deceased spouse’s IRA into your own IRA account.  Combining the funds will reduce the number of accounts and simplify your recording keeping.


In addition, if you inherit the IRA from your spouse, you can elect to be treated as a “non-spouse” beneficiary and utilize any of the methods described above.  Handling the IRA in this manner will allow a spouse under the age of 59 ½ years to receive the funds from the Inherited IRA without paying the 10% penalty.

Inheriting a Roth IRA

If you inherit a Roth IRA, the same rollover and distribution rules discussed above apply for both a spouse and non-spouse beneficiary.  However, the distributions are not subject to income tax.  For this reason, a Roth IRA is a very attractive asset to pass to children. If the child takes the option to distribute the Inherited Roth IRA over his/her lifetime, the account will continue to grow income tax-free.

Summary

Inheriting a traditional or Roth IRA can be a financial benefit to you and your family.  As the beneficiary of a traditional IRA, you have the opportunity to spread the impact of taxation over several years or even your lifetime.  If you inherit a Roth IRA, with proper planning, you can preserve the tax-free generating character of the account for you and your beneficiaries.

Kathy Hower, CFP, is Director of Financial Planning and Senior Wealth Advisor at Bedel Financial Consulting Inc.

  • Perspectives

    • New Child Tax Credit: Will You Benefit?

      Do you have children? The Child Tax Credit was one of last year's most hotly-debated topics. Several senators, including Marco Rubio, called for a comprehensive overhaul before approving the Tax Cuts and Jobs Act bill. Ultimately, substantial changes were made. Here’s how the changes to the Child Tax Credit may impact you...

    More

Subscribe

Name:
Company Name:
Email:
Confirm Email:
HTML
INside Edge
Morning Briefing
BigWigs & New Gigs
Life Sciences Indiana
Indiana Connections
INPower
Subscribe
Unsubscribe

Events



  • Most Popular Stories

    • Big Names Unveiled For Snake Pit

      The Indianapolis Motor Speedway is bringing in some major names in electronic dance music for this year's Indy 500 Snake Pit concert. The event is looking for its third consecutive sellout May 27 during the 102nd Running of the Indianapolis 500. 

    • Indiana Companies 'Most Admired' in Respective Industries

      Three Indiana companies are included with their peers on an annual World's Most Admired Companies list. Compiled by FORTUNE, the list includes 680 companies from a pool of around 1,500 candidates globally. Survey results from 3,900 executives, directors and securities analysts are used to determine 50 "All-Stars," which ranked in the top 25 percent of last year's surveys and in the top 20 percent of their industry.

    • New Child Tax Credit: Will You Benefit?

      Do you have children? The Child Tax Credit was one of last year's most hotly-debated topics. Several senators, including Marco Rubio, called for a comprehensive overhaul before approving the Tax Cuts and Jobs Act bill. Ultimately, substantial changes were made. Here’s how the changes to the Child Tax Credit may impact you...

    • Springbuk Plans 'Momentous Announcement'

      Indianapolis-based Springbuk is planning what it calls a "momentous announcement." Indianapolis Mayor Joe Hogsett will join the employer health data company for Monday afternoon's announcement at the Union 525 building downtown. Springbuk is headquartered at the downtown tech hub. Last summer, the company said its customer base had grown to 900, leading it to add about 10 employees.

    • 'Big, Audacious Project' Attracts San Fran Transplant to Fort Wayne

      One of the goals of Fort Wayne's $440 million Electric Works project is to attract talent to northeast Indiana. Before the first shovel of dirt is turned for the public-private partnership, it appears to be working. The project, planned for the historic former General Electric campus near downtown, has hired its first full-time employee. "I love the big, audacious project," said Crystal Vann Walstrom, Electric Works’ new Managing Director of Innovation.