Have you inherited an IRA? If so you may want to read this posting in particular as the rules are vastly different for an inherited IRA over your own. First if you are a spouse and named as a beneficiary you are allowed to roll the inherited IRA from your deceased spouse into your own and continue as if nothing has changed. By doing that, it allows deferral withdrawals until age 70 ½. If you are younger than that for a traditional IRA, you are not required to make withdrawals. If you inherit an ROTH IRA, there are no such requirements for a spouse. The key here is for the surviving spouse to name a proper beneficiary with the company that holds the IRA so further heirs can benefit from tax deferred growth. So what happens to you if you inherit an IRA and are not the surviving spouse? We will look at that next.
If you are anyone other than a spouse and inherit an IRA here are some of the differences, you will face. First if the surviving spouse does not name a beneficiary and leaves the IRA to their estate it will defeat the advantages of tax deferred growth. The simple reason is yes their children will get the funds as they wished through the estate after the probate process. But they will have to make their final withdrawal from the IRA at the end of the fifth year and they will not have the advantage of a child who inherited the IRA as a named beneficiary. If you name someone other than a spouse as the beneficiary, they are allowed to take the minimum withdrawals out of the IRA based on their projected lifetime. What this means is someone who is about 50 gets to spread the IRA withdrawals over the next 34 or so years where someone who inherited the IRA through their parent’s estate will only have five years. By naming the person as a beneficiary, they provide their heir about 30 years of tax deferred growth which they in turn can leave to their heirs as a lump sum payment. All of this is all dependent on the heir by transferring the money in the IRA to an inherited IRA. If heirs do not do this, they are subject to possibly having to take the full amount of the IRA as a lump sum payment with all the possible tax consequences.
It is important that the beneficiary roll the IRA into an inherited IRA directly. If an heir receives a check made out in their name, they are barred from rolling the funds into an inherited IRA. They will have possible tax ramifications depending on the type of IRA that was left to them. So it is important that anyone who inherits an IRA contact the managing company and convert it into an inherited IRA and never ask or request a check to do this yourself as that is not allowed. By doing this, it is in contrast to rollover IRA’s where you have 60 days to invest the funds from one IRA into a new IRA.
Once your heir has converted the IRA into an inherited IRA, they will have their lifetime to take the payments and spread out any possible tax consequences. But it is important that they make their minimum withdrawal from the IRA by December 31st of the year following the death of the original owner. If they do not make the minimum withdrawal by December 31st they will pay a 50% penalty on the amount, they should have withdrawn. The rules as slightly different if there are more than one heirs and they are of different ages and these steps are not followed so check with a tax professional if this occurs to you and your family.
In the event, you have an heir that has credit or financial problems you may consider a trust as your beneficiary instead of your children directly. The Supreme Court recently ruled that inherited IRA’s are not protected from creditors as individual IRA’s are. The main drawback of this process is trusts can be expensive to establish and can be extremely complex in nature. Currently, 43 states do not offer explicit protection for inherited IRA’s.
For more information on minimum distributions see IRS Publication 590, Individual Retirement Arrangements, or go to www.bankrate.com and look for their IRA distribution calculator. If you have any questions or want further clarification do not hesitate to contact me.
