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What to Do With Inherited IRAs

IRAs are usually among the largest assets inherited. These retirement accounts have been able to grow to such very large amounts because income taxes on the growth in the account are deferred until the owner begins to take distributions. (You may take distributions as early as age 59 1/2, but must take them at age 70 1/2).

Cash-Out Option: Anyone who inherits an IRA can cash it out and withdraw the full amount. But because income taxes must be paid on the full amount withdrawn, this is not usually the best choice.

Spouse IRAs: A surviving spouse who inherits an IRA from his/her deceased spouse can roll that IRA into a new IRA or merge it with an existing IRA. In either case, the account can continue to grow tax-deferred, and the surviving spouse can continue to make contributions to the IRA, until s/he must start take distributions at age 70 1/2.

If the IRA is rolled into a new IRA, the surviving spouse will be asked to name new beneficiaries. It is highly advantageous to name someone much younger (e.g., children and/or grandchildren) because future distributions to the beneficiaries will be based on their actual life expectancies. This allows the IRA to potentially stretch out for decades. In some cases, it may be advisable to make your Revocable Living Trust the beneficiary of your IRA.

Non-Spouse Options: If the original owner of the IRA died before taking distributions, a non-spouse beneficiary can establish a Beneficiary IRA and start taking distributions based on his/her own life expectancy, with the option to take a lump sum at any time. (Ask your financial adviser to describe the difference between the “life expectancy option,” and the “five year rule”).

If the original owner died after beginning to receive distributions, a non-spouse beneficiary must take a distribution equal to the owner’s required minimum distribution for the year he/she died if one had not yet been taken. In future years, distributions can be based on either the new owner’s life expectancy, or the original owner’s remaining life expectancy, whichever is longer.

The original owner’s name must be listed on the title, but the inheriting beneficiary will name new beneficiary(ies). A non-spouse beneficiary cannot roll an inherited IRA into his/her own IRA or make contributions to an inherited IRA. But when distributions are stretched out over a longer period of time, the tax payments are also stretched out. And by keeping more money in the IRA for as long as possible, the tax-deferred growth can be maximized…which will result in a much larger balance.

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