Have you inherited an IRA following the death of the owner? Are you the spouse of the original owner? Is the account a traditional IRA, Roth IRA, SEP, or SIMPLE IRA? These questions and more will be important to answer.
An inherited IRA is also referred to as a beneficiary IRA. You will soon learn that your first plan of action might likely be to move the assets from the original owner's account and place them in a newly opened IRA under your name. Keep in mind that the income tax treatment will remain the same for the original account as it is for the inherited IRA.
Let's take a look at the choices available to you and see how they stack up in accordance with your specific situation.
Spouses as beneficiaries
Spouses who inherit an IRA from their deceased partner have multiple options. They can choose to name themselves as the owner of the IRA and let the money that is already in the inherited retirement account continue to grow until they turn 72 years old. Another option is to roll the IRA over into another account and have the opportunity to name their own beneficiary. The minimum distribution rules will apply in both scenarios.
Non-spouse individuals as beneficiaries
If you're a non-spouse beneficiary, such as the child of a deceased parent or adult, the IRS will not allow you to roll the money from an inherited IRA over to one of your preexisting accounts. Instead, you'll have to transfer your portion of the assets into a new IRA that you have set up and formally named as an inherited IRA.
Additional contributions are not allowed with IRA accounts inherited by beneficiaries who are not also the spouse of the original owner of the IRA. Additionally, IRA beneficiaries must deplete an inherited IRA within 10 years of the account owner's death. This is a fairly new rule, applying only to inherited IRAs belonging to owners who died after Dec. 31, 2019.
There's no limit to how frequently you will need to withdraw money from the account as long as all of the funds have been taken out within 10 years' time. However, each withdrawal from an IRA will be counted as income, subjecting those who withdraw from an inherited IRA to taxes on the money they withdraw for the year during which they withdraw it.
Looking ahead and thinking about your own estate planning process, you may forget you have to look back as well, meaning you must consider how well the person whose IRA you inherited abided by what was required of them as well. Make sure he or she paid his or her required minimum distribution the year they died. If they did not, then it's your responsibility to make sure the minimum deposit has been made. If you forget to do so, you may find yourself liable for a penalty of 50% of the amount that was not distributed on time.
No matter your exact inheritance situation, make sure you keep in mind the type of IRA you have either inherited or will soon inherit. If you have received a Roth IRA, all of the taxes should be paid by the time the IRA becomes yours. If it's a regular IRA, you'll need to pay the taxes yourself, as the money inside of a regular IRA is considered pretax money.
And there's more …
This is just a simple introduction to a very complex topic. There are many other rules that IRA beneficiaries must abide by along the way. For example, you can leave an IRA in a trust, but this has to be done carefully or else the beneficiary will severely hinder or negate the options for the beneficiaries.
If you have inherited an IRA, think about your own situation and the specifics of it. Contrary to popular belief, your last will or a testament cannot override an IRA beneficiary designation, so make sure these documents are all updated. From there, be sure to speak with a qualified financial professional so that you are aware of the rules pertaining to an inherited IRA and the options available to you in relation to your specific situation.
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