If you inherit an IRA, you have several options for handling the funds — depending on your relationship with the original accountholder. However, be careful before you take any action: Tax consequences vary dramatically. The following is a simple summary.
A popular option for individuals who inherit an IRA from their spouse is to roll it over into a new or existing IRA in their own name. The advantage of this approach is that you do not need to start taking required minimum distributions (RMDs) until after you reach age 70½. The downside, if applicable, is that, if you choose to withdraw funds before age 59½, you will generally owe a 10% penalty in addition to any applicable income taxes.
If your goal is to maximize tax deferral, rolling the IRA into one in your name is your best bet. However, if you think you may need to access some or all of the funds before you turn 59½, other strategies allow you to avoid the 10% penalty. For example, you can withdraw the funds as a lump sum or over five years (if the accountholder was under age 70½), paying applicable taxes (but not penalties) as distributions are made. You can also transfer the funds into an inherited IRA, which allows some continued tax deferral but also the ability to take penalty-free distributions before age 59½.
If you inherit an IRA from someone who is not your spouse, you cannot roll it over into an IRA in your name. However, you can withdraw the funds as a lump sum or within five years (if the original accountholder was under age 70½), paying any applicable taxes (but no penalties) as distributions are made.
Another, often better, option is to transfer the funds into an inherited IRA for your benefit, but in the original accountholder’s name. An inherited IRA does not delay RMDs until you reach age 70½; however, it does allow you to stretch them over a long period of time. The start date for RMDs and length of the distribution period depend on the original accountholder’s age at the time of death. If the accountholder was under 70½, RMDs must begin by December 31 of the year following that person’s death and distributions are spread over your life expectancy.
If the original accountholder was 70½ or older, you have until December 31 of the year following the accountholder’s death to begin taking RMDs, with one exception: If the accountholder did not take an RMD in the year of his or her death, you must take one by the end of that year. In either case, distributions are spread over your life expectancy or the original accountholder’s life expectancy, whichever is longer.
Rules are Complex
The rules surrounding inherited IRAs are complex. So if you have any questions, particularly when it comes to taking RMDs, consult your tax and financial advisors.
For more information, contact Jacqueline Janczewski at [email protected], or call her at 312.670.7444. Visit ORBA.com to learn more about our Wealth Management Services.