As part of my ongoing series on handling the estate of a loved one, today I want to look at inherited IRAs.
My step-mother had a couple of IRA accounts. As you may know, with an IRA, you can select the beneficiaries that will inherit the account when you die. As such, the funds do not transfer through a will or the estate. Instead, the account transfers directly to the beneficiaries you select.
Tip: Select both primary and secondary beneficiaries for your IRAs, such as a spouse as the primary and your children as the secondary. This gives your spouse the option of disclaiming the IRA account and having it pass directly to your children.
The rules of inherited IRAs, however, are really complicated. So before I get to the 5 things you should know about these types of accounts, rule #1 is seek professional advice. In my case, Vanguard was extremely helpful. Because they do this for a living, so to speak, they can walk you through the required steps. So wherever you open your inherited IRA account, let them walk you through the process.
Inherited IRA–What You Need to Know
1. Spouse vs. Non-spouse: The rules of an inherited IRA are different for a spouse and everybody else. A spouse can elect to be treated as the owner of the IRA, rather than a beneficiary. That means, among other things, that you may be able to continue contributing to the IRA and your required distributions are different than non-spouse beneficiaries. IRS Publication 590 has some helpful information on the differences between a spouse and non-spouse beneficiary.
2. Forget the 60-Day Rule: Remember the 60-day rule that allows you to take money out of an IRA penalty and tax-free, so long as you put it back into the same type of IRA within 60 days? It doesn’t apply to inherited IRAs. And that means, among other things, that if you want to move the IRA to a new custodian, it needs to be through a direct transfer.
3. Understand your Distribution Options: For non-spouse beneficiaries, you have two options when it comes to distributions. You can chose to withdrawal money from the IRA each year, the amount determined based on your life expectancy. This is referred to as the “stretch option.” Or you can take all of the money out within five years of the original owner’s death. Those are your options. The good news is that there are no penalties for these withdrawals, even if you haven’t reached 70 1/2. The bad news is the distributions will be subject to income tax.
4. Make Up Your Mind: If you are going to select the stretch option, you must take your first required minimum distribution no later than December 31 in the year following the death of the original owner. Miss this deadline and you’ll be forced to follow the 5-year rule on distributions.
5. Remember Mandatory Distributions: If the original owner was 70 1/2 or older, he or she was required to make mandatory distributions each year. As a result, you need to find out if the owner made the required withdrawal during the year of their death.
As I said at the start, inherited IRAs are really tricky. So I can’t stress enough the importance of working with a professional to guide you through the process.