The rules governing inherited IRAs can be complicated. Here are the major issues.
Transferring inherited IRA assets
If you inherit an IRA from someone who isn't your spouse, your options are fairly limited. You can't roll the proceeds over to your own IRA, treat the IRA as your own, or make any additional contributions to the IRA.
What you can do is transfer the assets to a different IRA provider, as long as the registration of the account continues to reflect that the IRA is an inherited IRA and not your own.
If you inherit an IRA from your spouse, you have many more options. You can roll all or part of the IRA proceeds over to your own IRA. You become the owner of the IRA assets, and the rules that apply to IRA owners, not beneficiaries, apply from that point on. If you're the sole beneficiary of the IRA, you can also generally treat the inherited IRA as your own by retitling the IRA in your name. But you aren't required to assume ownership of an inherited IRA. You can instead continue to maintain the inherited IRA as a beneficiary. You might want to do this if you inherit a traditional IRA and you'll need to use the funds before you turn 59½ (distributions from inherited IRAs aren't subject to the 10% penalty that typically applies to early distributions from IRAs you own).
Required minimum distributions (RMDs)
Nonspouse beneficiary: Federal law requires that you begin taking distributions (called required minimum distributions, or RMDs) from the inherited IRA after the IRA owner dies. If the IRA owner died after turning 70½ and didn't take a required distribution for the year of death, you'll need to make sure to take that distribution by December 31 of the year of death in order to avoid a 50% penalty.
Spouse beneficiary: If you roll the inherited IRA over to your own IRA, or treat it as your own, then the RMD rules apply to you the same way they apply to any IRA owner--you'll generally need to begin taking RMDs from a traditional IRA after you turn 70½; no lifetime RMDs are required at all from a Roth IRA. If you don't roll the IRA assets over or treat the IRA as your own, then the same rules described above for non-spouse beneficiaries generally apply to you, except that you can defer receiving distributions until your spouse would have turned 70½.
Special rules--inherited Roth IRAs
Qualified distributions to a beneficiary from an inherited Roth IRA are free from federal income taxes. To be qualified, the distribution must be made after a five-year holding period. The five-year period begins on January 1 of the year the deceased IRA owner first established any Roth IRA, and ends after five full calendar years. If you take a distribution from an inherited Roth IRA before this five-year period ends, any earnings you receive will be subject to federal income taxes (earnings generally come out last). If you're a spouse beneficiary, and you roll the inherited Roth IRA over to your own Roth IRA or treat the inherited IRA as your own, then you'll be eligible to take tax-free distributions only after you reach age 59½, become disabled, or have qualifying first-time homebuyer expenses. You'll also need to satisfy the five-year holding period, but a special rule applies--the five-year period for all of your Roth IRAs will be deemed to have started on January 1 of the year you or your spouse first established any Roth IRA, whichever is earlier.
And speak to a financial professional if...
• You're sharing the inherited IRA with other beneficiaries. This can impact when and how you must begin receiving RMDs from the IRA.
• You don't want or need the IRA funds. You may be able to disclaim the IRA and have it pass to another beneficiary. This must be done in accordance with strict IRA rules.
• Any estate taxes were paid that are attributable to the inherited IRA. You may be entitled to an income tax deduction equal to the estate taxes paid.
Forefield Inc. does not provide legal, tax or investment advice. All content provided by Forefield is protected by copyright. Forefield is not responsible for any modifications made to its materials, or the accuracy of information provided by other sources. Submitted by Arthur J. Saylor, Saylor Wealth Strategies, 401 Walnut Street, Coshocton, OH 43812 (740-575-4782, www.saylorwealth.com. Registered Representative, Securites offered through Cambridge Investment Research, Inc. a broker-dealer, member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research Advisors, Inc. a Registered Investment Advisor.