Individual retirement accounts, or IRAs, can be a significant part of a person's net worth, particularly if the account has been open for many years and the owner has contributed to the account regularly. The proceeds of the IRA pass on to the beneficiary upon the death of the account owner, and distributions must be taken according to tax laws. Even with mandatory distributions, many of these accounts can grow significantly over the lifetime of the beneficiary.
From a Spouse
An IRA inherited from a spouse offers the most flexibility to the beneficiary. Under these circumstances, the spouse can choose to treat the IRA as her own by renaming the account in her own name or rolling the money over into her own IRA account. She must be the sole beneficiary to do this. If she treats it as her own IRA, she does not need to take mandatory distributions, and can even make new contributions to the IRA. If she chooses to treat it as an inherited IRA, she will need to take mandatory withdrawals, according to Internal Revenue Service regulations.
From Other People
An IRA that is inherited from someone other than a spouse is treated differently. If the person inheriting the IRA takes a disbursement from the account, she will owe taxes on that entire amount in the year that the disbursement is taken, at her normal rate for income. This could result in significant tax consequences. A non-spouse beneficiary cannot roll the money into her own IRA, but does have the freedom to allow the money to grow in the inherited account tax deferred while she takes the mandatory yearly withdrawals. To ensure the tax-deferred status, she should leave the account in the name of the original owner, and add a "for the benefit of" (FBO) designation to the owner's name.
A person inheriting an IRA must at the minimum take mandatory withdrawals from the account each year, based on her own life expectancy. For example, if you inherit from a parent an IRA worth $100,000 at age 40, your life expectancy according to IRS regulations is 43.6 years. (Appendix C IRS publication 590) Divide the balance of the account by the life expectancy to calculate the minimum required withdrawal. In this case, you must withdraw at least $2293.00 and pay income taxes on this money, but not a penalty for early withdrawal.
Inherited Roth IRA
The rules are different for an inherited Roth IRA. A spouse inheriting a Roth IRA may continue to contribute to the account or combine it with his own Roth IRA. A non-spouse beneficiary does not have the same privilege and must keep it in the separate account. While the contributions can be withdrawn tax-free at any time, the account must have been open for at least five years to withdraw the earnings tax-free.
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