Be sure you understand your options.
When the owner of an IRA passes away, his or
her heirs must be aware of the rules and regulations affecting the inherited IRA.
Ignorance could lead you straight toward a tax disaster.
Please note that this is simply an overview. Rather than use this article as a guide,
use it as a prelude before you talk to a financial services professional well-versed in
IRA rules and regulations.
First, make sure you have actually inherited the IRA.
Your spouse, parent or
grandparent may have left their traditional or Roth IRA to you in a will, but that
doesn’t mean you have inherited it. In all but rare cases, an IRA beneficiary
designation form takes precedence over any bequest made in a will or living trust.
(The same thing applies with annuities and life insurance policies.)1
So your first financial task is to find that beneficiary form.
- What if I can’t find the form? The financial firm serving as the custodian of the
IRA assets will usually have a copy. (If the IRA was opened decades ago, it may
- What if there is no beneficiary designated on the form? Then the financial firm
supervising the IRA will choose a beneficiary according to its rules and/or IRS
guidelines. It may decide that the decedent’s estate will be the beneficiary of
the IRA, which is often the poorest outcome in terms of taxation.1
- What if I’m not the beneficiary named on the form? The IRA assets are
destined to go to whoever the named beneficiary is. If the named beneficiary is
deceased, the IRA assets will be inherited by the contingent beneficiary (if one
has been named).
Ideally, the original IRA owner has told you where (or left instructions where) to find
Understand the rules for spousal and non-spousal heirs.
If your husband or wife has
passed and you are the named beneficiary of his or her Roth or traditional IRA, you
have three options.
- You can roll over the assets into a beneficiary IRA. This enables you to
withdraw money from the IRA based upon your own life expectancy – and you
can wait until the year in which the original IRA owner would have turned 70½
to start taking required withdrawals from the IRA.2
- You can convert the inherited IRA into your own IRA. If you don’t have an IRA,
you can create one for this purpose. This gives you the ability to name your
own beneficiary, and it also allows you to keep contributing to the account and
put off required minimum distributions (RMDs) until you turn 70½.2
- You can “disclaim” all or some of the inherited IRA assets. If you don’t want or
need the money from the inherited IRA, here is another option. By doing this,
the income distribution off the IRA can go to the contingent (or successor)
beneficiary. Spousal IRA heirs sometimes do this with the goal of reducing
income and estate taxes.3
- If the inherited IRA is a Roth IRA, the surviving spouse may not have to wait so
long to get tax-free income distributions off the earnings. While the original
contributions to a Roth IRA can always be withdrawn tax-free and penalty-free,
a Roth IRA owner must wait 5 years to avoid income tax on any earnings
withdrawn from the account. However, a surviving spouse who inherits a Roth
IRA can receive “credit” toward this 5-year waiting period for the years that
the deceased spouse owned the IRA. The waiting period ends either a) 5 years
after the deceased spouse opened the account or b) 5 years after the surviving
spouse has opened his or her own Roth IRA.4
Non-spousal heirs often get little or no guidance when it comes to inherited IRAs. Too
often, the financial firm overseeing the IRA just asks, “What do you want to do?”
Often the IRA heir doesn’t know what to do.
So if you inherit an IRA, read up on the rules.
- Ask the financial firm to help you retitle the inherited IRA. This will enable
you to arrange a direct rollover of the inherited IRA assets from the original IRA
owner’s financial custodian to the financial firm that serves as the custodian of
your investments. This has to be done by September 30 of the year following
the year in which the original IRA owner passed away. This is also a necessary
move to “stretch” the IRA assets. Usually the new title for the IRA is something
like “Mary Jones IRA/Deceased 4/8/2010/ FBO (for the benefit of) Thomas
Jones as beneficiary.” This retitling signifies to the IRS that this is an inherited
- You should be made aware of the consequences if you don’t retitle the
inherited IRA. Let’s say you don’t retitle the inherited IRA as above. Instead,
you just withdraw the assets from the inherited IRA and deposit them an IRA
you have held for some years now. If you do this, the entire inherited IRA
balance will be treated as taxable income and your federal tax bill could be
- You should be made aware that you can name a beneficiary. All IRA owners and
IRA heirs have a right to do this. No named beneficiary, no stretch IRA.
- If you weren’t married to the original IRA owner, you should be told some
inherited IRA basics. Non-spousal heirs of IRAs can’t contribute to an inherited
IRA and can’t put off required minimum withdrawals from an inherited IRA.5
- You don’t necessarily have to take a lump sum when it comes to withdrawing
the IRA assets. This is one way inherited IRAs are quickly depleted. A
beneficiary can arrange to make smaller required minimum distributions (RMDs)
from the inherited IRA according to his or her life expectancy. These
withdrawals must start by the end of the year following the year in which the
original IRA owner passed away. If you don’t start taking these required
withdrawals by December 31 of the following year, you will pay a penalty.
Taking smaller withdrawals allows some of the IRA assets to stay invested with
tax deferral, and it spreads the income tax liability on the inherited IRA money
over a multi-year period.4,5
- You may be eligible for a big tax deduction related to income distribution off
the IRA. Income from an inherited IRA is what the IRS terms “income in respect
of a decedent”. This means you can take an income tax deduction for the
portion of the estate tax attributable to the inherited IRA (this is detailed in
IRS Publication 590).6
- If multiple beneficiaries are inheriting the IRA, you should be informed that
you might be able to split the IRA up. When multiple beneficiaries inherited an
IRA years ago, they had to share it and make joint investment and withdrawal
decisions. Now it is possible to divide an inherited Roth or traditional IRA into
multiple IRAs, one for each beneficiary. (Ask the IRA custodian if it will allow
Knowledge is truly an asset when you
inherit sizable funds from any kind of retirement account. The more informed you are
and the more guidance you have, the better the potential outcome.
Tom Kestler may be reached at 800-699-0299 or firstname.lastname@example.org
This material was prepared by Peter Montoya Inc., and does not necessarily represent the views of the presenting party, nor
their affiliates. This information should not be construed as investment, tax or legal advice. The publisher is not engaged in
rendering legal, accounting or other professional services. All information is believed to be from reliable sources; however, we
make no representation as to its completeness or accuracy. If assistance or further information is needed, the reader is advised
to engage the services of a competent professional.
1. investopedia.com/articles/pf/07/beneficiary_form.asp [3/23/11]
2. jhrollover.com/article_beneficiary_basics_final.shtml [3/23/11]
3. investopedia.com/articles/retirement/03/041603.asp [4/16/03]
4. online.wsj.com/article/SB125634328917505043.html [10/24/09]
5. online.wsj.com/article/SB125512471450876777.html [10/10/09]
6. irs.gov/publications/p590/ch01.html 
7. montoyaregistry.com/Financial-Market.aspx?financial-market=an-introduction-to-the-stock-market&category=29 [3/27/11]