Inherited IRA RulesWith the exception of financial experts, deciphering the rules of individual retirement accounts can often leave a person confused and frustrated.

Actually, scratch that.

Even financial experts can get stumped on the inherited IRA rules.

While the gist of most IRAs is relatively easy to comprehend, once a person begins investigating the rules – requirements and exclusions – things tend to get a bit tricky.

This becomes even more apparent when you find yourself named as a beneficiary of an IRA from a friend or family member who has passed.

Inherited IRAs constitute some of the largest assets left in an estate.

For this reason any heirs who find themselves in a position of deciding what to do with an inherited IRA should think carefully about all the options before making their final decision.

I’ve had many clients that have been faced with this very decision.

Most are tempted to just cash it in and buy <fill in the blank> which is usually some item they just don’t flat out need.

Please don’t be this person.

Since this decision can have a huge impact on your own personal finances (in both positive and negative ways) most beneficiaries will benefit by consulting with a tax professional or financial advisor experienced in this area.

The following information is provided to help you understand what options are available to you regarding inherited IRA rules. Distribution of assets for some IRAs must begin at age 70 1/2 (April 1 of the year following this birthday), therefore some of the options are based on whether the owner of the IRA died before or after that cut off date.

Be sure to name at minimum a primary beneficiary on your IRA so that they can benefit from the inherited IRA rules. It would make this financial advisor even happier if you named a secondary beneficiary. I’ve seen too many instances where family feuds erupted because the IRA owner (usually mom or dad) did not take care of this simple task.

1| Five year rule of Inheriting an IRA

When the owner of the IRA does not specify a beneficiary or simply names the estate as the beneficiary, the rules for withdrawal or distribution of assets state the entire amount of the IRA must be distributed by December 31st of the fifth year following the death of the owner. This five year rule applies if the owner of the IRA passed away before mandatory distributions began. If the owner of the IRA had already passed the mandatory distribution age, the distribution of the IRA must follow the terms elected by the owner.

2| Non-spousal beneficiaries

For non-spouse beneficiaries who inherit an IRA after the minimum distribution date has passed, options are fairly limited. In most cases you would have to follow the same distribution schedule set forth by the owner of the IRA, this includes collective life expectancies or recalculating life expectancies.

If the owner of the IRA passes away prior to the mandatory distribution date, you may elect to have the entire balance distributed within five years or over a period not to exceed your life expectancy.  This is what is referred to as a stretch IRA.

3| Inheriting an IRA from a Spouse

If the owner of the IRA was your spouse, you have the same options available to you as that of a non-spouse beneficiary. In addition, you may opt to treat the inherited IRA as your own which would eliminate the minimum distribution rules that normally apply after the owner of the IRA has passed. If this option is taken, the surviving spouse then becomes the owner of the IRA and the benefits and rules apply to the surviving spouse not the decedent.

This is simply done by contacting the brokerage firm that is the custodian of the IRA and having them “re-title” the account into your name.   If you’re not sure what is the best option for you, Smart Money has a really good article on inheriting your spouse’s IRA here.

Understanding Inherited IRA Rules = Muy Importante!

As you can see there are many rules and restrictions that apply to the distribution of IRAs after the owner has passed. As the beneficiary of an inherited IRA, it is imperative that you research and understand all of the rules and restrictions to avoid making decisions that will cost you money down the road, either in the form of lost earnings or paying too much to the government.

By handling the inherited IRA in the best possible manner, you have the opportunity to benefit from the inheritance as the owner surely intended when they named you as a beneficiary.


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Comments | 1 Response

  1. Suzie says

    Today being indecisive about such a major area in my life, I learned:
    (1) Rollover into new or existing IRA in your own name using using Tax Table of 17.0 divided into $100,000 will provide RMD of $3,640.64
    (2) Transfer assets to an “inherited” IRA using Tax Table 27.4 divided into $100,000 will provide RMD of $5,882.35.
    Essentially the Rollover “extends the life of your money” while the Transfer “moves the money out at a faster rate”.
    Transfers are good for those couples who ages are further apart and need access to monies now and no 10% penalty if you take withdrawals from an inherited IRA prior to age 59 1/2 as you would if you were withdrawing assets from a non-inherited IRA.

    I am opting for the “Rollover” to ensure my monies do not run out!

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