A radio listener once told me that his father had recently passed away. His father had named him as the beneficiary of his IRA. He wanted to know if he could transfer his dad’s IRA to his own IRA. Inheriting an IRA brings with it some important rules that need to be followed very closely. One of the biggest risks is not getting the account set up right. It is VERY IMPORTANT to transfer the IRA to a new “inherited” or sometimes called a “beneficiary” IRA (a surviving spouse has the option of transferring to their own IRA, but it may not be in their best interest). The new IRA should list the deceased person’s name and then your name as beneficiary. You can’t withdraw the funds and then “roll over” the distribution to an inherited IRA later (within 60 days). That rule does not apply to an inherited IRA.
If you want to minimize income taxes, you need to begin taking the Required Minimum Distribution (RMD) by the end of the year following the year the original owner died. The IRS provides a table that shows how much you need to withdraw, based on your age. Once you find out that number (basically your estimated life expectancy), you simply subtract one from that number each year following to calculate how much you are required to take out for that tax year. If you don’t start taking a distribution by the end of the year following the death of the owner, you will need to distribute the entire IRA by the end of the fifth year. With the five-year rule, you don’t have any RMDs. You can take some out each year or even wait until the fifth year and take it all out.
You can invest the money in the IRA the same as you invest in your own IRA. You can even transfer the IRA to a different custodian or bank, if you are not satisfied with the current custodian or if it would be more convenient for you. The main issue is to be sure you take your RMDs each year.
What if you change your mind after eight years and you need the money. Can you take more than the RMD each year? The answer to that question is, fortunately, yes. Another plus is that you still won’t have to pay a 10% early withdrawal penalty, since the distribution is coming from an inherited IRA.
Another caution/reminder is that inherited IRAs are not eligible for a Roth Conversion or the Qualified Charitable Distribution (age 70½ and older).
Once the new inherited IRA is set up, you can name any beneficiary you want for the IRA. Subsequently, if you pass away and your beneficiary inherits your inherited IRA, your beneficiary will be required to withdraw the RMD based on your age, not their own (including a spouse). Keep in mind that they can always take more than the RMD each year, without penalty.
IRA distribution rules can be confusing, so it is important that you discuss your situation with a professional before making any very important, and often irrevocable, decisions.
