The rules surrounding an inherited IRA are a bit more complicated than the ones you run into when you open and fund your own account, and which ones will apply largely depend on what category of beneficiary you fall into: spouse, child or non-spouse, or an entity like an estate or charity. Each of these groups has its own set of rules about taxation and withdrawals. If you inherited an IRA, here’s what you should know.
Inheriting an IRA from a spouse
Inheriting an IRA from a spouse is the simplest of the three scenarios. As their widow or widower, you can either retitle the IRA into your name or roll the money in it over into a new IRA.
If it’s a Roth IRA, you can withdraw any funds tax-free if the account has existed for at least five years. If it hasn’t been five years, you’ll have to wait until that point to take tax-free withdrawals. Rolling an inherited IRA into a new or existing Roth IRA is a good method for anyone who doesn’t want to take money out of the account, and would rather let it keep growing and compounding.
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For a Traditional IRA, the inheritance rules are slightly different. You can withdraw all the money, but you’ll have to pay income taxes on the full amount. You also can transfer the funds from the inherited IRA into your own Traditional IRA, but you’ll have to make the typical RMDs. If you’re not 59 1/2 years old and take a withdrawal, you’ll be subject to a 10% early withdrawal penalty.
Inheriting an IRA as a non-spouse or entity
If you inherit an IRA from one of your parents or another family member, you won’t be able to retitle it into your own name, but you will have the option to transfer the funds in it over into a new account. You can also cash out the full amount as a lump-sum distribution. If it’s a Roth IRA, the withdrawal will be tax-free as long as the account is at least five years old. If it’s a Traditional IRA, you’ll pay income taxes on the funds you withdraw.
With Traditional IRAs, non-spouse beneficiaries can’t make contributions to the inherited IRA or roll over any amounts into or out of the inherited IRA. However, the beneficiary can make a trustee-to-trustee transfer as long as the IRA into which amounts are being moved is set up and maintained as an inherited IRA in the name of the deceased IRA owner for the beneficiary’s benefit.
Non-spouse beneficiaries typically have to withdraw the entire amount from their inherited IRA within 10 years of the original owner’s death. There are exceptions for minor children of a deceased person and those who are less than 10 years younger than the decedent. In those cases, heirs might be able to take required minimum distributions (RMD) based on their life expectancy.
Seek help if need be
The rules around inherited IRAs can be confusing to navigate, but getting clarity about them can help you avoid unexpected penalties or tax bills. If you find yourself feeling overwhelmed with the various options, don’t shy away from seeking help from a professional who can ensure you understand all implications of your choices. That could save you a lot of headaches – and potentially, a lot of money.
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