Suppose a loved one dies, and you find that you are the beneficiary of his or her IRA. Your assumption could be that you have received an inheritance that is tax-free—just like the proceeds from a life insurance policy. In fact, this may or may not be true. Current tax laws state that while the IRA you have received as a beneficiary is indeed tax-free, any required minimum distributions you take could be taxable. This is at least partially dependent on what type of IRA you received as a beneficiary.
Further, should you fail to take those required minimum distributions in the allotted time, you could face significant penalties. To be clear, you can take all of the funds at one time, or as much of the IRA as you choose, so long as all the required minimum distribution rules are properly satisfied. All of the issues related to an inherited IRA become exponentially more important if you are over the age of 50 when you receive the IRA. Let’s look at this issue more closely.
- If you inherit a “traditional” IRA (one which employed tax-deductible contributions), an income tax must be paid on the distributions— however, there will be no early distribution penalties involved, even if you and the deceased owner are/were both under the age of 59 ½. In some cases, a traditional IRA could have had both deductible and non-deductible contributions. If this is the case, then a portion of each distribution will be taxable.
- Roth IRAs are totally tax-free, so long as the owner of the IRA held the Roth IRA for a minimum of five years. If the five-year period has not elapsed, however, the distributions are tax-free only when they are a representation of the owner’s recovery contributions.
No matter which type of IRA you have inherited, you are still required to take out an annual amount (required minimum distribution) over a specific period of time. As noted, failing to do so could result in a 50 percent penalty on the amount which should have been withdrawn. It is important to note that IRA inheritance rules for spouses involve different rules. The goal of the required minimum distribution is to deplete the funds in the account, so the accumulations will not last forever.
You are allowed to postpone distributions on an inherited IRA, so long as the account is emptied by the end of the fifth year following the death of the owner of the IRA, or you can use another RMD method which involves taking the required distributions over life expectancy. If the original IRA owner was not at least 70 and six months (and already taking required minimum distributions), then you should use your own life expectancy. You can find your life expectancy in the Single Life Expectancy Table of IRS Publication 590-B. By and large, most of those who inherit an IRA choose to take life expectancy payments rather than following the five-year rule.
Surviving Spouse Rules for Inherited IRA
Surviving spouses of an IRA owner who are the sole beneficiary of the IRA can either act in the same manner as any other beneficiary, or can treat the account as his or her own by naming themselves as the account owner, or by rolling the IRA into their own account. If your spouse died prior to the age of 70 ½, you do not have to start receiving required minimum distributions until that year. If your spouse was younger than you are, you may choose to treat the IRA as any other beneficiary would because your required minimum distributions will be delayed until the younger deceased spouse would have turned 70 ½ years old.
If your spouse left you a Roth IRA, you could treat it as though it were yours all along, therefore, you will not have to worry about the required minimum distributions. There is one special caveat—if you are aged 70 ½ or older when you inherit the IRA, you can transfer up to $100,000 from the IRA directly to a qualified charity, which is tax-free, and can include required minimum distributions which then become non-taxable.
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