Nobody likes to talk about death, but planning ahead with your loved ones is a must when it comes to inherited money. Beneficiaries of IRAs have several options available to them once they receive an account, or their share of an account, but some decisions require quick action to prevent major loss of funds. Read on below to learn more about the three general options available to you when you inherit an IRA.
- Roll over into own account. If you are the spouse of the deceased, you can easily transfer the funds from the IRA or Roth IRA into your own account, and the money acts as if it was yours the whole time. You will still have the same penalties on early distributions and be required to pay tax from any distributions you take from a traditional IRA. While there are no required minimum distributions (RMDs) on a Roth IRA, the RMDs will be based off of your own life expectancy, and not the original owner’s, for a traditional IRA once you reach 70 ½.Keep in mind that you have only 60 days to transfer these funds into your own account if there are multiple beneficiaries listed to inherit the IRA. Non-spouse inheritors don’t have the option to transfer the funds into their own IRA, but have two other options available to them.
- Open an Inherited IRA. The main benefit to transferring funds into an Inherited IRA for spouses and non-spouses alike is that funds are accessible any time without incurring a penalty for early distribution. However, any distributions from a traditional Inherited IRA count as part of your gross income and will be subject to tax.Another quirk to Inherited IRAs and Inherited Roth IRAs is that you are required to take RMDs, but you have a few different paths to schedule your RMDs. If the original IRA owner was younger than 70 ½, you can either make the first RMD by December 31st of the year following the year of death, and then continue RMDs based on your own life expectancy, or distribute all the funds by December 31st of the fifth year after death. If you fail to take the first RMD by the deadline, it will default to the five year plan. A spouse also has the option to wait for the first RMD until after the original owner would have turned 70 ½.If the original owner of a traditional IRA was already 70 ½ at the time of death, the RMD they owed that year must be paid first before December 31st of the year of death. Then, you must take your first scheduled RMD by December 31st the year following death and continue a schedule based on your own life expectancy. If there are multiple beneficiaries to the account, all funds must be transferred into individual accounts by December 31st following the year of death for RMDs to reflect personal life expectancies; otherwise they will default to the life expectancy of the oldest beneficiary.
- Lump sum distribution. The least advised, but sometimes necessary, third option is to distribute all of the funds at once as a lump sum. You will avoid any early distribution fees with this method, but will owe income tax on distributions made from a traditional IRA. The extra income may also move you into a higher tax bracket. As long as the five-year holding period has been met for a Roth IRA, you won’t owe any taxes on your distribution.
An inherited IRA can be extremely useful in building your own retirement funds if managed properly, but an inheritor must be aware of the strict deadlines associated with these accounts to avoid unnecessary fees and penalties. The best way to ensure a smooth transition of funds is to double check any beneficiary paperwork before death. You don’t want simple mistakes to cost thousands in the long run.