IRAs allow the owner of the account to name a beneficiary, who will take over ownership of the account when he dies. In addition to inheriting the money that is in the account, the beneficiary also inherits some interesting tax benefits, and the ability to potentially take a lifetime income from the account. Special rules govern the required withdrawals from an inherited IRA, and you must follow these rules to preserve the tax benefits of the inherited IRA.
If you inherit an IRA, there is no maximum distribution amount that you can take from the account. You can withdraw the full balance of the account immediately, or within five years from the time that you inherit the account. If you do this, you will end any tax-deferred or tax-free growth of the account, and if your inherited IRA is a traditional IRA, you will pay annual taxes on the distributions you take, at your normal income tax rates.
Spousal Inherited IRA
Special rules apply to an IRA that you inherit from your spouse. You can treat a spousal IRA as your own account, continuing to contribute to the account or putting it in your own name. You can also take distributions on your own schedule, delaying any mandatory distributions from a traditional IRA until you are age 70 1/2. If you inherit a Roth IRA, you do not have to take mandatory distributions from it if you choose to treat it as your own account.
Non-Spousal Stretch IRA
A non-spousal beneficiary who chooses not to liquidate the account within five years will need to begin taking distributions from the IRA immediately in order to stretch the distributions out over his own life expectancy -- or the life expectancy of the deceased, had she lived. For example, if you inherit an IRA at age 40, the IRS beneficiary life expectancy table says that you will live another 43.6 years. If the inherited account has a balance of $300,000, you can divide the balance by 43.6, to arrive at the minimum distribution for the year of $6,880.74.
Advantages of Stretching Distributions
By stretching your inherited IRA distributions for as long as possible, you continue the tax-deferred growth with a traditional IRA, or the tax-free growth with a Roth. With a $300,000 balance, and an annual return on investment of 8 percent, your IRA will earn $24,000 per year. If you are 40, and required to take a distribution of $6,880.74, even after this distribution the IRA will be worth $317,119.26 the following year. Taking the lowest possible distribution could ensure the growth of the account for many years.