For most, receiving an inheritance is never less than pleasant, whether it is a surprise or has long been expected. The occasion of such a windfall seems like an ideal opportunity to fortify your savings. If you have done a handy job of shoring up your present financial situation on your own, it might occur to you to direct inheritance money toward retirement savings. Be aware that the Internal Revenue Service does not allow any inherited money to be contributed to any IRA -- Roth or traditional. If your spouse dies, you may roll his IRA into your own.
IRS regulations state that IRAs must be funded with earned income. The definition includes wages, salaries, tips, self-employment and commission income. In addition, alimony and taxable military pay are considered earned income. Funds from inheritances, pensions, annuities and Social Security or disability payouts, however, do not qualify as earned income and therefore cannot be contributed to an IRA.
Yearly Contribution Limit
The IRS places a limit on how much you can put into an IRA each year. As of 2012, the limit was $5,000, or $6,000 for those age 50 and greater. Moreover, you can only place as much money in an IRA as you have earned, up to the limit. For example, if you earn just $2,000 in a given year, you can contribute only $2,000 that year.
Inherited IRA vs. Personal IRA
If you inherit a Roth or traditional IRA from anyone other than your spouse, you can take the money as a lump sum, take distribution of the entire account within five years, or take yearly distributions based on your life expectancy. Whatever choice you make, you are entitled to open and fund your own personal IRA, even as you receive distributions from your inherited IRA. You must pay income tax on any distribution from a traditional IRA. A Roth inheritance is not subject to personal income tax. If the decedent had not owned a Roth for at least five years, you have to pay a 10 percent penalty on any earnings you withdraw from the inherited Roth. Alternatively, you can wait until the five years have passed and then withdraw the earnings money tax-free.
Spousal Inherited IRA
If your spouse dies and leaves you a Roth or traditional IRA, you can roll the funds into your own personal IRA. Roth funds must be rolled into a Roth; inherited traditional IRA money would go into your own traditional IRA. As an inheriting spouse, you are not required to take any distributions of the inherited IRA money; the inherited funds you put into your personal IRA are not subject to any special rules. You treat the inherited money in your personal account as your own IRA money and can continue to make yearly contributions or withdrawals as usual.
- Stockbyte/Stockbyte/Getty Images