Laws on Inheriting Money From an IRA
The Internal Revenue Service's regulations on inheriting individual retirement accounts all depend on your relationship to the decedent. If you're the widow or widower, there's one set of rules. For anybody else, your inherited IRA choices are much more limited. The guidelines on IRA inheritance can be confusing, so if you're the beneficiary of an inherited IRA, consult your financial adviser to make sure you aren't making any mistakes that could cause you to incur financial penalties.
If you're the surviving spouse, you have several choices. You can roll over the assets of the inherited IRA into your own IRA. If it's a traditional IRA, you base the mandatory required minimum distributions withdrawals on your own age. You can also roll over a traditional IRA and convert it into a Roth IRA, although you must pay taxes on the conversion. However, Roth IRAs do not require mandatory minimum distributions, and any withdrawals you do make are tax free. You can also choose the options available to non-spousal beneficiaries.
If the decedent wasn't your spouse, you should set up an inherited IRA account by the last day of the year in which the individual died. Once you do this, you can opt for a cash distribution of the account, which is considered part of your annual gross income for tax purposes. You can also leave the assets in the inherited IRA account, and begin taking required minimum distributions by December 31 of the year after the original account owner died, based on your own life expectancy according to IRS life expectancy tables. If you choose this option, make sure you continue to make these withdrawals each year by December 31, or the IRS will penalize you 50 percent of the amount that should have been taken out.
Both spousal and non-spousal beneficiaries can opt out of the IRA inheritance altogether, but it's not as simple as just telling the IRS you'd like someone else to have the money. You must formally disclaim all or part of the inherited IRA within nine months after the decedent's death. The amount you disclaimed then passes to the next eligible beneficiary that the decedent stated it should go to, not whom you might want to have it. Required minimum distributions then depend on the beneficiary's age. If the decedent was a parent and the next eligible beneficiary is your child, by disclaiming the inherited IRA you allow for "stretching" the time available for tax-deferred growth on the funds.
No Listed Beneficiary
If the person died without listing an IRA beneficiary, who gets the account depends on the financial institution's default beneficiary policy. For many IRA fiduciary custodians, the surviving spouse receives the IRA, but for some it automatically becomes part of the decedent's estate and passes to designated beneficiaries. In that case, if the account owner was alive on April 1 of the year he turned 70½, the required minimum distributions are based on his life expectancy according to IRS tables as if he were alive. If the account owner was under 70½ at the time he died, all assets must be distributed by the last day of the year of the fifth year after his death.
A graduate of New York University, Jane Meggitt's work has appeared in dozens of publications, including PocketSense, Financial Advisor, Sapling, nj.com and The Nest.