IRAs are unique creatures. There are very specific rules that apply when these are inherited. There are several distribution options that apply to both spouses and non-spouses. Each option has its own tax implications. Regardless of your relationship, you can:
- Inherit the IRA. You can transfer the proceeds into an inherited IRA for your benefit so that the assets can grow tax-deferred. You can then take distributions over your lifetime and enjoy the benefit of tax-deferred growth on the assets remaining in the inherited IRA.
- Take a lump-sum distribution of the assets. Once you've inherited the IRA, you can take a lump-sum cash distribution. However, you'll lose the benefit of tax-deferred investing and, because the money counts as ordinary income for the year in which you receive it, you may end up with a sizable tax bill.
- Refuse to take ownership of the assets. You have the right not to take the inheritance. This refusal is called "disclaiming" the inheritance. If you do, the surviving primary beneficiaries, or secondary beneficiaries if there are no other primaries, are entitled to the undistributed amounts.
If you inherit an IRA, whether it's a traditional or Roth, the IRS requires you to take at least some of the account balance out each year. It's called a required minimum distribution (RMD). (Depending on your situation, you may be able to wait until you reach age 70½ to take your first RMD.)
The amount of your first RMD and when you need to take it to avoid tax penalties are based on a few factors:
- Your status as a surviving spouse, a spouse who's also one of several beneficiaries, or a nonspouse beneficiary.
- The date of the original owner's passing and whether the owner was older or younger than age 70½ at the time of death. In most cases, you'll need to take your RMD by December 31 of the following year. However, if the owner passed after reaching age 70½, you may also be responsible for taking the owner's remaining final RMD by December 31 of the year of death.
- If other beneficiaries were named. The life expectancy used in the RMD calculation depends on whether each beneficiary has established his or her own inherited IRA by December 31 of the year following the original owner's death. If so, you can use your own life expectancy. However, if the account isn't split into separate IRAs by the deadline, the oldest beneficiary's age is the one used to determine the RMD amounts for all the beneficiaries.
Before you decide on a distribution option, you should talk to an attorney who has experience with these decisions. The potential tax implications and loss of tax-deferred growth are serious issues with substantial financial consequences.