How to Handle Your Inherited IRA

IRAs are becoming a common asset in estate plans, sometimes the largest asset
of the estate.  They can, however, be a tax trap for the unwary.  Inherited IRAs
are treated differently depending on the age of the decedent and who inherits the

Treatment of an IRA varies depending on whether the owner died before he was
to  take  the  Required  Minimum  Distributions  (RMDs)  (age  70  ½)  or  during  the RMD period.  There are four possible beneficiary designations.  The beneficiary can be a spouse, a non-spouse, both a spouse and non spouse or no beneficiary named.    Let  us  examine  how  distributions  would  be  handled  in  each  possible situation.

Spouse as Beneficiary

A spouse has four options with respect to the inherited IRA:

1.  Roll over – A spouse can roll over the IRA into her own existing or new
IRA.    She  can name her own  beneficiaries,  continue  contributing  to  this
IRA and need not begin RMDs until she, herself, is 70 ½.

2.  Remain  a  beneficiary –  On  the other hand, the  spouse  can  treat  the
IRA as a beneficial or inherited IRA and continuing the distribution pattern
of  the  deceased  owner.    This  might  be  advantageous  if  the  surviving
spouse is much older than the deceased spouse or is younger than 59 ½
and wishes to take distributions without penalty.

3.  Cash out the IRA – Amounts withdrawn would be immediately taxable.

4.  Disclaim  or  give  away  the  account  –  If  the  spouse  was  well  off
financially,  she  might  choose  to  forego  her  right  to  receive  the  IRA  and
allow it to pass to the contingent beneficiaries.  Doing so would spare her
the  income  tax  when  the  account  is  withdrawn  and  might  spare  her
children additional estate tax when she dies.  A disclaimer must be done
within nine months of the date of death.

Non-spouse as Beneficiary

Before RMD – When the owner has named someone other than the spouse or
someone  in  addition  to  the  spouse  as  primary  beneficiary,  the  distribution  will
need to be made within 5 years of the last day of the year of the owner’s death,
unless the beneficiary elects to take distribution over a period not exceeding his
or her own life expectancy.  If there are multiple beneficiaries, the life expectancy of the oldest will be used.  To avoid this, the beneficiaries may segregate the IRA account so each can use his own life expectancy.  It is especially important to
separate the IRA if one of the beneficiaries is a charity as such entities have no life expectancy and must distribute within 5 years.

During  RMD  –  If  the  owner  was  already  receiving  RMDs,  the  remaining
distributions must continue to be made in the same way and cannot be spread
over a longer life expectancy.  Non spouses must keep the inherited IRAs totally
separate  from  other  funds  and  cannot  make  additional  contributions  to  the

No Beneficiary Named

If no beneficiary is named or the named beneficiary has predeceased, the IRA
distribution will go to the owner’s probate estate.

Before  RMD  –  Since  the  estate  has  no  life  expectancy,  the  entire  IRA  would
need  to  be  distributed  no  later  than  the  last  day  of  the  5th  year  following  the owner’s  death.   The  administrator  of  the  estate  has  two  options:

(1)  he  could maximize the tax deferral by waiting until the end of the 5 year period to withdraw all of the money or

(2) he could spread the distributions out over the five year
period and spread out the tax liability.

During RMD – The estate administrator would have no option but to follow the predetermined  plan  of  the  deceased  owner.    If  the  IRA  owner  was  taking withdrawals over the term of his life expectancy, this would be continued by the estate beneficiaries.

Inheriting  an  IRA  can  be  a  real  windfall,  but  it  is  important  to  understand  and consider  the  options  available  to  take  the  best  tax  advantages.    Discuss  your options with your attorney and accountant immediately as the timing of elections is critical.

IRA  owners  should  consider  the  ramifications  of  their  choice  of  primary  and contingent beneficiaries on their family and loved ones.  Those with a charitable intent might consider designating a charity as beneficiary since charities pay no income tax on the IRA.  Designating IRA beneficiaries is an important part of your estate plan and should be discussed with your attorney and your accountant.


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