Written By Lori A. Curtis
Whether you have inherited an individual retirement account (IRA) or are deciding on who should be the beneficiary of your own IRA, there are some key concepts you need to understand so that you can make the best decision for you and your family.
If you inherit a traditional IRA, you are called a beneficiary. Before she dies, the owner of the IRA can choose any person or entity to receive the benefits of her IRA. In most circumstances, beneficiaries of a traditional IRA are taxed on any distributions they receive from the IRA.
If you have inherited the IRA from your spouse, you have the option of transferring the IRA into your own IRA. This means you can delay taking the minimum required distributions (MRDs) until you are 70½ years old. However, it also means you may have to pay an early withdrawal penalty if you take the money out before you reach the age of 59½. If you plan on withdrawing the funds before that time, you may want to treat yourself as the beneficiary instead of transferring the funds into your own IRA.
If you have inherited the IRA from someone other than your spouse, you cannot treat the IRA as your own. You must either withdraw the entire amount within five years of the owner’s death (at which time you will pay taxes on the entire amount), or, if you wish to keep it in an IRA, you must make what is called a “trustee-to-trustee” transfer. You will need to retitle the IRA, and the name of the account must include the original owner’s name, and indicate it is inherited an inherited account, such as “Mom, deceased, inherited IRA for the benefit of Beloved Child, beneficiary.”
Like the original owner, you will not owe taxes on the account until you receive any actual distributions. There are specific IRS rules that specify when beneficiaries must begin taking these distributions, so if you inherit an IRA, you should contact the plan administrator or custodian immediately to verify when you will need to begin taking distributions.
The most important thing to remember is that when it comes to IRA’s or other retirement accounts, the beneficiary forms dictate where the funds will go. Simply naming a beneficiary in your will or listing the IRA on one of the exhibits in your trust is insufficient to name a beneficiary. You MUST correctly fill out the beneficiary form on file with the custodian of the account.
If the owner of the IRA fails to name a beneficiary, different financial institutions have different policies. In some cases, it goes first to a spouse, then to the estate. Some custodians simply send it straight to your estate, oftentimes triggering a probate. Few custodians will pass on an IRA directly to children without them being specifically named on the beneficiary form.
Further, if a trust, estate, charity, or business entity is named as the beneficiary, the rules are a bit different. There are many other distribution rules and tax traps for the unwary. If you have inherited an IRA, or if you are trying to decide who to name as the beneficiary of your own IRA, we suggest you call Davis Miles McGuire Gardner.