When it comes to inheriting assets, few are as complicated as an IRA. The rules for surviving spouses are different than for non-spouses, but rules for both are complex and mistakes are costly.
Perhaps the most important thing to do when you inherit an IRA is your homework. Start by finding out exactly the type of IRA you have inherited, and then find out what kind of beneficiary you are. USA Today's article, "If you inherit an IRA, make a plan before doing a thing," starts with the premise that the person inheriting the IRA is a surviving spouse, and outlines four options.
- Roll the inherited IRA assets into your own IRA. This has several advantages. The beneficiary can postpone required minimum distributions (RMDs) until age 70 ½, and beneficiaries can use their own life expectancy to calculate RMDs. Plus it's pretty easy. You don't have to keep both an inherited IRA and your own IRA, they can be combined, but the disadvantage is that the beneficiary will (with a few exceptions) have to pay a 10% penalty tax on pre-59 ½ distributions, and RMDs could be accelerated if the deceased spouse was younger than the surviving spouse.
- Transfer assets into a properly-titled inherited IRA. There are a few advantages to this. For starters, the spouse beneficiary won't have to pay the 10% penalty tax when taking withdrawals from an inherited IRA prior to age 59 ½. Also, you may be able to delay RMDs if the deceased spouse was younger. However, this is pretty complex. The beneficiary will have to keep their own retirement accounts separate from their inherited IRA.
- Convert the decedent's IRA to the survivor's Roth IRA. This can be done, but you'll want to work with an experienced estate planning attorney to avoid expensive surprises in the future. The surviving spouse might choose this option if they expect to be in a higher tax bracket later in life, but they should also consider the tax brackets of those who might inherit their Roth IRA.
- Disclaim all or part of the assets. Again, this involves a meeting with an experienced estate planning attorney. The advantages are that you might be able to have assets pass to younger beneficiaries, using their own life expectancies for RMDs, and keep assets out of the surviving spouse's estate. You'd likely choose this option if the estate wasn't set up properly, or if the surviving spouse doesn't need the money. One drawback is it's irrevocable, and there's no control over where the money goes.
The rules are different for a non-spouse beneficiary. You may not roll over the inherited IRA assets into an IRA in your name. You have two options: (i) transfer assets into an inherited IRA—you'll have to take RMDs from the inherited IRA, but they'll be based on your age and life expectancy rather than that of the original account owner; or you can (ii) disclaim all or part of the assets. Remember these points:
- Funds have to be transferred to an inherited IRA by December 31st following the year of death for non-spouse beneficiaries to "stretch" the plan assets over their life expectancies;
- Custodians or plan administrators don't have to offer to calculate RMDs for inherited IRAs—beneficiaries may be on their own; and
- Non-spouse beneficiaries must usually take RMDs from their inherited IRAs yearly starting the year after the death of the owner.
This is not a do-it-yourself, figure it out and get help later matter. Without the guidance of an experienced estate attorney and great care, the possibility exists for the inherited IRA to be consumed by taxes.
Reference: USA Today (March 15, 2016) "If you inherit an IRA, make a plan before doing a thing"