Inherited an IRA? Here’s what you need to know | Smart Change: Personal Finance

(Stefon Walters)

The rules surrounding an inherited IRA are a little more complicated than the ones you encounter when you open and fund your own account, and which ones apply depend largely on the category of beneficiary you fall into: spouse, child or non-spouse, or a entity such as an estate or charity. Each of these groups has its own rules about taxes and withdrawals. If you inherited an IRA, here’s what you need to know.

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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 put the IRA in your name or transfer the money in it to a new IRA.

If it’s a Roth IRA, you can withdraw tax-free money if the account has been around for at least five years. If it hasn’t been five years, you’ll have to wait until then to make tax-free withdrawals. Converting 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 grow and worsen.

For a traditional IRA, the inheritance rules are slightly different. You can withdraw all the money, but you will have to pay income tax on the full amount. You can also transfer the money from the inherited IRA into your own traditional IRA, but you’ll need to make the typical RMDs. If you are not 59 1/2 years old and make a withdrawal, you will 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 relative, you cannot put it in your own name, but you do have the option to transfer the money in it to a new account. You can also pay the full amount in one go. If it’s a Roth IRA, the withdrawal is tax-free as long as the account is at least five years old. If it’s a traditional IRA, you pay income tax on the money you withdraw.

With traditional IRAs, non-spouse beneficiaries cannot make contributions to the inherited IRA or roll amounts into or out of the inherited IRA. However, the beneficiary can make a transfer from trustee to trustee as long as the IRA to which the funds are moved is established and maintained as an inherited IRA in the name of the deceased IRA owner in favor of the beneficiary.

Non-spouse beneficiaries typically must withdraw the full 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 for children who are less than 10 years younger than the deceased. In those cases, heirs may be able to take the required minimum benefits (RMD) based on their life expectancy.

Seek help if you need it

The rules surrounding inherited IRAs can be confusing to navigate, but getting them clear can help you avoid unexpected penalties or tax bills. If you feel overwhelmed by the variety of options, don’t hesitate to seek help from a professional who can ensure you understand all the implications of your choices. That can save you a lot of headaches – and potentially a lot of money.

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