IRA as an Inheritance

IRA as an Inheritance
A Spouse Inherits

If you are a spouse who inherits an IRA from your husband or wife, you can put the IRA in your own name ("re-title" it) -- this is the simplest way -- or roll the money, tax-free, into a new IRA, in your name.  

If it's a Traditional IRA, you can leave the money alone until you reach 70 1/2, at which time required minimum distributions begin.  With a Roth IRA, any money you don't need can stay in the Roth for the next generation.

There is a "tax wrinkle" for younger spouses.  If you need the IRA money, you can potentially owe a 10% penalty, if you withdraw money and are under 59 1/2.  You can avoid the penalty by re-titling the account as an "inherited IRA."

The rules on re-titling are very specific.  As an example, say John Jones dies, leaving his IRA to his young wife, Mary Jones.  The account should be re-titled "John Jones IRA (deceased August 01, 2012) for the benefit of Mary Jones, Beneficiary."  Once this is done, Mary Jones can take the money penalty-free.  There is one more step -- younger wives, please note.  When Mary reaches 59 1/2, she should re-title the account again, this time in her name alone.  This lets her defer any further withdrawals until she reaches 70 1/2.  If she doesn't do this, withdrawals must start when her late husband would have reached 70 1/2.

A Child or Non-spouse Inherits
If a child receives an IRA from a parent, the child cannot roll the money into an IRA in the child's own name.  If the child decides to cash out, two things happen:
1)  if it's a Traditional IRA, the child will owe income tax,
2)  the multi-year (even multi-decade) tax shelter that an inherited IRA provides would be lost. 

So, the child should re-title the account as an "inherited IRA."  For example, say John Jones leaves his IRA to his daughter, Joan.  Joan should re-title the IRA "John Jones IRA (deceased August 01, 2012) for the benefit of Joan Jones, Beneficiary."  If the money is to be divided among heirs, each recipient should re-title his or her share.  Every year, the child is required to take a minimum withdrawal, based upon the child's age, but the child can take more if they want.  Remember, withdrawals are taxed, the remainder accumulates tax-deferred.

Now, if Joan dies, naming her son, Jack, as beneficiary, Jack can re-title the account as an "inherited IRA" and complete the withdrawals on the same schedule that Joan began.  The family deferrals could last for decades.

What if you inherit a 401-K?  That too can be re-titled as an "inherited IRA."

If re-titling is wrong, the recipient will be taxed immediately, on the whole amount.  A lawyer who handles the will can assist heirs in re-titling IRA's.  Or, send a letter to the mutual fund group that holds the IRA, specifically asking that a separate "inherited IRA" for each beneficiary be created.

Anyone holding an IRA or 401-K should leave a "note" explaining re-titling so their heirs can get as much tax deferral as possible from the money you leave them.

Synopsis:
Rollover to beneficiary
Distributions of benefits from a deceased employee's eligible retirement plan may be rolled over directly to an IRA of a beneficiary who is not the surviving spouse of the employee [IRC §402(c)(11)].  The IRA is treated an an inherited IRA of the beneficiary.  Distributions from the inherited IRA are subject to the distribution rules applicable to beneficiaries.  A non-spouse beneficiary who inherits an IRA cannot treat it as his or her own account but must take RMDs determined under the rules applicable to beneficiaries receiving distributions from a qualified plan.  

When an individual other than the decedent's spouse receives a lump sum distribution from an IRA, in general, the individual may not roll over that distribution into another IRA, it must be distributed within a certain period [IRC §401(a)(9) 408(d)(3)].  The distribution, minus aggregate amount of non-deductible IRA contributions, is taxed as ordinary income in the year the distribution is received (Rev. Rul. 92-47).

This law does not change the rule that allows a surviving spouse to treat an inherited IRA as his or her own IRA, or to roll funds from a deceased spouse's employer-sponsored pension plan or IRA over to his or her own IRA or employer-sponsored pension plan. [IRC §402(c)(9)]

Beneficiaries of a Traditional IRA generally must receive a RMD from the inherited account for each year after the year of the IRA owner's death.  "Designated beneficiaries" (named by the IRA account owner or designated under the plan as of the date of death) as a beneficiary, may spread distributions over their life expectancy.

If you inherit your spouse's Traditional IRA and you are under 70 1/2, you may delay the start of RMDs by treating the IRA as your own.