Inheriting an IRA


ReShelle Barrett, CFP®

The term “IRA” tends to be used fairly loosely. Although most investors know that it means individual retirement account (or sometimes annuity), many don’t realize there are multiple types of IRAs which are similar on one hand but can be very different on the other. Types of IRAs include traditional, Roth, SIMPLE, Rollover, and inherited/beneficiary IRAs. This article focuses on what an inherited IRA is and how it works.

When an IRA is originally established, a beneficiary is named. That is to whom the assets will transfer upon the owner’s death. In most instances, when a spouse is named as beneficiary, the ownership transfers directly to the surviving spouse seamlessly and the account continues to grow tax deferred (or tax-free for a Roth IRA) until that owners passes. If there is no beneficiary on an IRA either due to not naming one initially or if the beneficiary predeceases the owner, the assets then go into the deceased account owner’s estate and get distributed according to their will. It’s important to know that an estate is almost never recommended as a beneficiary because all the income taxes are due upon the owner’s death and the net balance is what gets transferred to the estate for distribution.

When a beneficiary is named on an IRA, the account does not pass through the deceased owner’s will (non-probate) so the transfer is typically done in a relatively fast, easy manner. So, if you are a non-spouse beneficiary of an IRA, then you have a few options for the new inherited IRA.
First, the full amount can be liquidated without penalty, regardless of age. This is unlike a traditional IRA where most withdrawals are only allowed penalty-free after attaining age 59 ½. All distributions are taxed as income for Federal Income Tax purposes. Also worth noting is retirement distributions are NOT taxed at the state and local level in Pennsylvania, including inherited IRAs.

Another option is to leave the IRA invested for tax-deferred growth for the new owner’s retirement. If this option is chosen, annual required minimum distributions (RMD) must be taken every year for as long as the inherited/beneficiary IRA exists. The exact amount is based on the account value at the end of the prior calendar year and the birth year of the beneficiary. The RMD amount is recalculated each year. Additional distributions over and above the required minimum can be made at any time, penalty free.

Inherited IRAs cannot be combined with other traditional IRAs as they are treated differently for income tax purposes.

The account can also be transferred to another IRA custodian as you wish. It is not required to stay with the original custodian or investment advisor.

As you can there are distinct differences in inherited IRAs and as a beneficiary, you have some options to consider. So if you are on the receiving end of an inherited IRA, talk to an advisor to learn more about maximizing your options based on your current needs as well as future goals and objectives.

ReShelle L. Barrett, CFP®

Contact ReShelle L. Barrett, CFP®

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