For your own safety, frequently repeat the following, “IRAs are particularly complicated animals.” Doing so will remind you to seek expert help in dealing with them. The subject of inherited IRAs frequently causes confusion for those designated as the beneficiaries. While you may have heard that inheritances are generally tax-free, withdrawals from an inherited traditional IRA are not. In fact, minimum distributions are required from any IRA you inherit, be it a traditional IRA or a Roth IRA. And, the minimum distributions from a traditional IRA are taxable as ordinary income.
If you inherit an IRA, be aware that our tax code distinguishes between spousal and nonspousal beneficiaries. If you do inherit an IRA from your spouse, you have the advantage of being able to combine the inherited IRA into your own IRA. In this situation, you are not subject to the minimum distribution rules associated with inherited IRAs. However, you are still subject to distributions starting for age 70 ½.
If you inherit an IRA from a friend or a relative who is not your spouse, you do not have the same luxury. You must establish a beneficiary IRA account and transfer the inherited IRA funds into that account. Then, you are required to start taking minimum distributions from that account. All amounts withdrawn are taxable as ordinary income, as long as they are not from a Roth IRA.
As a nonspouse beneficiary, you have one advantage. All withdrawals, whether required or elective, are not subject to the 10% penalty, even if you are not 59 ½. This issue is extremely important if you do inherit from your spouse, you are not yet 59 ½ and you may need to access those funds. Instead of combining into your IRA, you may want to leave the amount in the beneficiary IRA so you can withdraw without the 10% penalty.
Remember, if you inherit a Roth IRA, the withdrawals are not taxable but they are still required.
Another word of warning, be careful with required distributions. If you inherit both a traditional IRA along with a Roth IRA, the required distributions must be taken from each one respectively.
Inherited IRAs require great care. Not only must the account be titled correctly, but the funds must also be transferred properly. The inherited funds can only be moved as a direct transfer to you as the new beneficiary. You may not do a 60 day rollover, nor can you withdraw the funds and replace them within 60 days. This is simply not allowed. Inherited beneficiary IRAs also cannot be converted to Roth IRAs.
Reread this article. You will notice “not” used frequently. There are so many dangerous issues of which to be aware. In fact, they are too numerous to all be explained here. Inheriting an IRA, along with designating a beneficiary, often involves income tax, estate planning and perhaps even generation-skipping transfer tax issues. Always obtain expert and experienced counsel when dealing with IRA issues.
Repeat the phrase, “IRAs are particularly…”