What is an Inherited IRA?

It is an individual retirement that is left to a beneficiary (spouse or non-spouse) after the owner’s death. If the owner had already begun receiving required minimum distribution (RMD’s) at the time of his or her death, the beneficiary must continue to receive the distributions as already calculated or submit a new schedule based on his or her life expectancy.

Potential tax implications and/or penalty situations for the inheritor of individual retirement account (IRA) assets can result from a lack of knowledge and awareness either when the IRA owner sets up the account or in the way the beneficiary accepts the assets. The beneficiary can be a spouse or non-spouse.

Here at Camuso CPA PLLC, we provide consultations and services for better understanding and ease in doing business. We will help you understand better what are the rules for inherited IRAs?  The tax traps?  The benefits?

Treating an inherited IRA depends on how you answer the following questions. Were you married to the person who left you the IRA as an inheritance? Had the IRA owner reached the age at which required minimum distributions had to be made?

Tax laws surrounding inherited IRAs are quite complicated. Beneficiaries should seek the advice of a tax professional if they inherit an IRA. If the owner of an IRA dies before complete distribution of assets, regardless of the specifications of a will or a trust, it’s important that the IRA’s designated beneficiaries be clearly named. Naming beneficiaries requires a clear understanding of those rules and the distribution implications. Be permissible under IRS rules for tax deferral purposes.  If the process adheres to the IRS’s strict requirements funds inherited from an IRA can be received by beneficiaries and not be subject to income taxation until distributed later.

From a tax standpoint, it is generally agreed that the most efficient choice is to create an inherited IRA in the name of the deceased for the benefit of the beneficiary. In this way, the beneficiary will be required to take RMDs using their life expectancy. That will result in lesser tax than taking the money now or even over 5 years.

Inherited IRA Distribution Rules

Spouse inherited an IRA

Most Commonly those who inherit an IRA from a spouse transfer the funds to their own IRA.

      Spouse the owner of inherited IRA was under 70 ½

  • Spouse can transfer assets to his/her existing or new IRA at any time but penalty may apply to withdrawals made before age 59 ½.
  • You transfer the assets into an inherited IRA held in your name but distributions must begin no later than 12/31 of the year the account holder would have reached 70 ½. Your annual distributions are spread over your single life expectancy which is determined by your age in the calendar year following the year of death and is reevaluated each year. RMD’s are mandatory and you are taxed on each distribution. You will not incur 10% early withdrawal penalty. Undistributed assets can continue growing tax deferred.
  • Open an Inherited IRA -5 Year Method. At any time up until 12/31 of the fifth year after the year in which the account holder died, at which point all assets need to be fully distributed. He or she is taxed on every distribution but will not incur 10% early withdrawal penalty and undistributed assets continue growing tax-deferred for up to 5 years.
  • Lumpsum Distribution. All assets in the IRA are distributed to you and money is available all at once. You will pay income taxes on the distribution all at once. You will not incur 10% early withdrawal penalty. You may move to a higher tax bracket depending on the amount of the distribution and current income level.

     Spouse the owner of IRA was over 70 ½

  • Transfer assets into your own existing or new IRA. Penalty will apply to withdrawals made before you reach age 59 ½. IRA assets can continue to grow tax deferred. Must take RMD for the year of death if the account holder did not take it. If under age 59 ½ you will be subject to the same distribution rules as if IRA had been yours originally.  Can’t take distributions other than RMD for the year of the death without paying 10% early withdrawal penalty.
  • Must begin taking an annual RMD in the year of death. RMD must be taken from the account by 12/31 of the year the original account holder died.
  • Annual distributions are spread over your single life expectancy, RMD’s are mandatory and no 10% early withdrawal penalty
  • Lumpsum distribution. Money is available all at once. You will pay income taxes on the distribution. You will not incur the 10% early withdrawal penalty. You may move to a higher tax bracket depending on the amount of the distribution and your current income.

Non-Spouse inherited an IRA

A non-spouse is not allowed to rollover the inherited IRA into his/her own IRA but distributions are allowed without paying the 10% penalty for early withdrawal. A non-spouse inherited IRA can:

1.Cash out an IRA

2.Take out required minimum distributions over his/her own life expectancy

3.Take out required minimum distributions over the oldest beneficiary’s life expectancy

4.Cash out the IRA immediately

What I have discussed above are just some of the few significant information one must know about inherited IRA. If you have inherited an IRA, just do not ask the IRA custodian for advice about what to do with your inheritance, and do not simply withdraw 100% of the funds as soon as possible. Instead, take a deep breath, and then consult a tax accountant to determine which option will work the best in your situation.

Here at Camuso CPA PLLC, we do have the ability to offer services to our clients. If you are interested to know more about this and how this might benefit your business, please don’t hesitate to give us a call today. One of our friendly and knowledgeable representatives will be happy to answer any questions you have.