With the exception of financial experts, deciphering the rules of individual retirement accounts can often leave a person confused and frustrated. 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. 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.
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.
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.
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.
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.
This is a guest post from Junior Boomer who runs the blog Consumer Boomer, aimed at the Baby Boomer generation. Consumer Boomer is not endorsed or affiliated with LPL Financial.
This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
photo credit: VoisineN
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