tA non-spouse who inherits an IRA generally has three
Remain a beneficiary. In this case, you'll
transfer the IRA assets into a beneficiary distribution account,
also called a beneficial IRA, described earlier. It remains an IRA,
with both your name on the account as beneficiary and the deceased
person's name as the original account holder. Example: "John
Smith IRA (deceased April 12, 2004) F/B/O (for the benefit of) Elizabeth
Make certain the financial institution does not put
the IRA directly into your name. Doing so would make the inherited
IRA fully taxable in one year.
As the beneficiary of an inherited IRA, you will forevermore
need to make at least the annual required minimum distributions
from the inherited IRA, regardless of your age. The age 70 1/2 guideline
for beginning withdrawals no longer applies to this inherited account.
You'll need to make withdrawals every year -- withdrawing the entire
amount either within five years or "stretching" it over
your life expectancy.
Non-spouse beneficiaries usually also can move an
inherited IRA, via a direct trustee-to-trustee transfer, to another
financial institution. In addition, Goetting says, you can change
the way the money is invested. For instance, if your dad invested
his IRA money in bond funds, you aren't stuck with his choices,
she says. You can opt to reinvest the money in growth mutual funds.
Cash out the account so it is no longer an IRA.
"If you cash out the account, keep in mind that the funds are
immediately considered taxable income for that year," Goetting
says. She suggests talking with a tax pro before you make this decision,
especially if a significant amount of money is involved.
Give it away. If you're doing well financially,
you might choose to give your inherited IRA to someone else so the
account can grow tax-deferred over a lifetime. This option should
be discussed with the original IRA account holder while still living,
counsels Hughes. You may also need to seek legal advice.
One way to handle this situation, Hughes says, would
be to have the original account holder -- your mother, for instance
-- designate your son as her IRA beneficiary to begin with. Another
option would be for your mom to list you as the primary beneficiary
and your young son as the contingent, or secondary, beneficiary.
"In the latter case, you could then choose to
disclaim, or give up control of, the IRA while the estate is being
settled. The account would then pass to your son, the contingent
beneficiary," Hughes says.
A "disclaimer," also known as a "renunciation
form" in legalese, is a written statement of the primary beneficiary's
desire to give up the inherited IRA. In most cases, a disclaimer
must be filed with the court within nine months of the original
account holder's death or by Sept. 30 of the year following the
account holder's death, whichever is earlier.
However, says Hughes, the key to this entire giveaway
is that your son must be listed on the deceased mom's original IRA
contract as the approved contingent beneficiary. You cannot simply
give the tax-deferred account to him on your own, after your mother's
If a parent wants to leave an IRA to several designated
beneficiaries, he or she can take action while still living to separate
the account. For instance, if a father has three children, he can
divide his IRA into three separate IRAs and designate each child
as the beneficiary of one of the accounts. This move can simplify
things once the father dies and the estate is distributed.
The taxman is watching
A particularly important factor to consider after inheriting an
IRA is whether the original account owner had begun taking
annual withdrawals from the account. Why? If you don't know whether
withdrawals have begun, you could give the IRS an opportunity to
step in and take a significant portion of the account in taxes and
If the account owner was 70 1/2 or older when he died,
he should already have begun taking annual distributions."If
not, the IRS can assess a 50 percent penalty on the amount that
should already have been taken out. The estate must handle these
penalties and any owed taxes before beneficiaries -- you -- receive
any money," explains Goetting.
Also, if you simply sit on an IRA after inheriting
it and fail to continue taking distributions, you'll end up with
a big tax and penalty bill later. The amount you, as the designated
beneficiary, are required to withdraw from an inherited IRA can
vary. Goetting and Hughes both stress that you shouldn't count on
the financial institution that handles your IRA to be familiar with
inheritance rules. A tax professional is a wiser choice for guiding
you through these muddy waters.
The Roth IRA difference
Unlike traditional IRAs, the Roth is not subject to distribution
rules, so the account holder is not required to start distributions
at 70 1/2. And upon the account holder's death, a spouse can keep
the Roth IRA intact, roll the proceeds into a new or existing IRA
account and may continue to contribute to the account. There would
be no requirement to take distributions.
A non-spousal beneficiary, on the other hand, must
take distributions either by the end of the year marking the fifth
anniversary of the account holder's death or over the life expectancy
of the beneficiary, starting no later than Dec. 31 of the year following
the year the account holder died. No matter how the beneficiary
decides to take the Roth IRA distributions, none would be subject
to the 10 percent early withdrawal penalty.
The tax consequences of these choices should
be considered on an individual basis and only after consulting with
a tax expert.
Don't miss the deadline
A final caveat: Don't wait too long before deciding how to handle
your inherited traditional IRA.
You have a little time on your side; the designated
beneficiary of an inherited IRA doesn't need to begin taking distributions
from the account until Dec. 31 of the year following the IRA account
holder's death. However, "Keep in mind that just as the IRS
doesn't accept ignorance of tax laws as a reason for breaking them,
it also doesn't accept grief as an excuse. It's unfortunate but
true," warns Hughes.
For more information, refer to IRS
Publication 590, Individual Retirement Arrangements, or Montana
State University's publication: "Inheriting
an IRA: Planning Techniques for Primary Beneficiaries."
Many financial institutions also have information available on inheriting
IRAs. An informative book on IRAs, with a full section on "stretch
IRAs" is "The
Retirement Savings Time Bomb .. and How to Defuse It" by
Teri Cettina is a freelance writer in Oregon.