Making the wrong move with an inherited individual retirement account usually means a steep bill come tax time. The way you handle an inherited IRA depends on the relationship you had with the person who left it to you. For example, the rules are different for an IRA left by your spouse than for an IRA left to you by your parent. Whatever you do, talk to an adviser before you begin taking money from the IRA to avoid adding to your tax bill.
Make the inherited IRA your own. You can only treat an inherited IRA as your own if you inherit it from your spouse after he dies. Treat the inherited IRA as your own by putting your name on the account or by rolling it over to your own IRA plan, an employer retirement plan or annuity plan. You'll need to make a contribution to the IRA and not take a distribution from it during the first year.
Act as a beneficiary of the IRA instead of making it your own. You need to have the IRA renamed something along the lines "Bob Smith IRA (Date of Death), for the benefit of your name, beneficiary." If you are under the age of 59 1/2 and make yourself the beneficiary, instead of making the IRA your own, you can take distributions from either a traditional or Roth IRA without penalty, according to the AARP.
Give up the IRA. If you don't think you'll need the money from the IRA, you can give up your right to it, according to Fidelity. The IRA would pass on to other named beneficiaries, if there are any.
Cash out the entire inherited IRA at once. Taking a lump sum distribution of the IRA means you'll owe money on the amount at tax time if it was a traditional IRA.
Rename the IRA and take the required minimum distributions based on your age. You need to rename the IRA as a beneficiary IRA, such as "Bob Smith IRA (Date of Death), for the benefit of Your Name, beneficiary." If you choose this option, you need to take your first distribution before Dec. 31 of the year after the person died, according to Bankrate.com, or else you'll have to empty the entire IRA within five years. The amount you need to take out each year depends on the age of the person you inherited the IRA from and your own age.
Pass on the IRA. You can decide to give up an IRA you inherit from someone who isn't your spouse as well.
- If you inherit an IRA from your spouse, you can treat it as your own only if you are the only beneficiary.
- If more than one beneficiary is named on the IRA, you should divide the amount of the IRA up and each make your own Inherited IRA.
- If you don't take the required minimum distribution from the inherited IRA, you face a big penalty. Failing to take the RMD means a tax of 50 percent of the amount of the distribution.
- You might owe tax if the person had a traditional IRA and was required to take a RMD but hadn't yet done so the year he died.