When dealing with the loss of a loved one, you’re often times tasked with managing their assets. One major asset is their IRA. An Inherited IRA is an individual retirement account that is left to a beneficiary following the owner’s death. It’s important to take the time to understand the ins and outs of this inheritance, which we’ve boiled down to five basic factors.
The Type of IRA – Traditional or Roth
Traditional IRA account owners must begin taking a required minimum distribution (RMD) by April 1 following the year they reach age 70½ . Subsequent RMDs must be taken annually by December 31 each year. All distributions are taxable as ordinary income. Roth IRAs do not have an RMD, distributions are never required and earnings are not taxed during the account holders lifetime.
The Relationship of the Beneficiary to the Deceased – Spouse, Non-Spouse, Trust, Charity or Estate
How the inheritance is managed is determined by the type of beneficiary – spouse, non-spouse, trust or estate – as well as other factors. Often times either a spouse or non-spouse is a beneficiary of an IRA. Rules for trusts and estates get more complex and are beyond the scope of this article. A spousal beneficiary is a person that was married to the original account holder at the time of death; whereas a non-spouse beneficiary is exactly as the name implies – a person that wasn’t married to the account holder. The relationship determines how the beneficiary takes title of the IRA. If the beneficiary is the spouse, he/she may roll the inheritance into their own IRA; a non-spouse beneficiary cannot.
Age of Original Account Holder at the Time of Death
The age of the original account holder only has an effect on Traditional IRAs. If the original account holder was over the age of 70 ½, it eliminates one of the options available to a spousal beneficiary.
Has the Original Account Holder Commenced RMDs (Required Minimum Distributions)
If the original account holder had commenced RMDs, than the beneficiary must suffice the RMD by the end of the calendar year in which the IRA was inherited. In subsequent years, the spousal beneficiary might continue using the life expectancy of the deceased to increase distributions or roll it into their own IRA to reduce the required amount based on their younger age.
Roth IRAs: The Date the Account was Established
The date of establishment on a Roth IRA is critical. Remember that money goes into a Roth IRA after tax and therefore contributions are always distributed tax-free. In order for the earnings distributions to remain untaxed, the account must be open for at least 5 years. If the earnings are distributed before five years, the earnings are taxable, but penalty free.
Be Mindful of Deadlines
The IRS imposes deadlines for setting up Inherited and Spousal Rollover IRAs. All deadlines occur in the year following the death of the account holder.
No matter the type of beneficiary (spouse vs. non-spouse), the first distribution must occur by December 31st of the year following the original account holder’s death. Distributions are treated as taxable income to the beneficiary. From a legal standpoint, it is also important to consider the fact that Inherited IRAs are not protected from creditors in bankruptcy under federal law.
Understand Your Options
Inherited IRAs are available to any beneficiary upon the death of the account holder of an IRA or other qualified retirement plan. Possible beneficiaries and options are as follows:
- A spouse may roll the IRA into an existing IRA or into an Inherited IRA. The assets remain tax-deferred until the IRA requires they be distributed.
- If a non-spouse, the beneficiary may open an inherited IRA, keeping the assets with the same tax advantages.
- The beneficiary may elect to take a lump-sum distribution.
The spousal rollover IRA is an option that allows a spouse to roll the assets into most traditional or Roth IRAs. It is a great way to continue to defer distributions further into the future, especially if the spouse is younger than the original account holder. The Inherited IRA is open to both spouse and non-spouse beneficiaries and can be either a traditional or a Roth IRA.
Regardless of the type chosen, a beneficiary must move the assets from the original IRA and cannot continue to take distributions from the original account holders IRA. Also, contributions are permitted for most spousal Rollover IRAs, while contributions are not permitted for Inherited IRAs.
In the end there are many things to consider when inheriting an IRA. It is not recommended that one go it alone. The assistance of a qualified professional will help guide you through a sometimes daunting process and work to ensure there are no missteps along the way.
This information is for educational purposes only and should not be considered investment advice or an offer of any security for sale. Investing risks include loss of principal and fluctuating value.
About the Author
Working with a financial advisor may help simplify your financial picture and provide you with piece of mind.
George Damasco is an Investment Advisor at MPM Wealth Advisors. He has worked with individuals and small businesses around the country to create clear, holistic and customized investment plans aimed at achieving his clients’ financial goals and lasting from generation to generation. Visit www.mpmwealth.com to learn more or schedule consultation.