What to Know If You’ve Inherited an IRA

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More than a third of American adults have an individual retirement account. That means plenty of people could find themselves in the situation of inheriting one. What options do you have, and what steps should you take, if you inherit an IRA? It depends who you inherited the IRA from.

If you’re inheriting from a spouse

The IRS says you have a few choices:

  • Designate yourself as the new owner of the account. This is also known as retitling and can be the easiest way to handle an inherited account. But it’s worth talking with your financial planner or an advisor at the brokerage firm to ensure you’re making withdrawals at the right time. In general, IRA account holders who make withdrawals before age 59.5 are hit with a 10 percent penalty, and starting at age 70.5 they must start taking out money (known as required minimum distributions). When you inherit an IRA and retitle it in your name, you’ll follow the age-related rules according to your age, not your spouse’s.
  • Retitle the account with yourself as the beneficiary instead of the owner. This can be a clever workaround for spouses who need access to funds in an inherited IRA but are younger than 59.5 (which would typically mean a penalty for any withdrawals). Rather than being retitled in your name directly, the account is retitled as an inherited account. That means the account holder becomes, for example, “John Doe (deceased January 1, 2018) for the benefit of Jane Doe, beneficiary.” The rules on retitling are very specific, so you’ll want to consult with a financial professional.
  • Roll the IRA into a traditional IRA of your own. This can be a new account or an existing one. This option also means you’ll take required minimum distributions according to your own age.
  • Take a lump sum distribution. This means you may owe income taxes on the money from the account, though you won’t have to pay the 10 percent early withdrawal penalty. This sudden boost to your income could also push you into a higher tax bracket, meaning you’ll owe more in income taxes. And once you’ve taken the money out, you can’t put it back into an IRA.

Spouses who don’t take the lump sum should take the time to understand what the account is invested in and if it meets their needs, experts say.

If you’re inheriting from someone else

If you inherit the account from someone other than a spouse, the IRS does not allow you to designate yourself as the owner. You also can’t contribute to the IRA or roll any money into or out of the account. You have only two choices:

  • Transfer the money into an inherited IRA under your name. You must begin making required minimum distributions by Dec. 31 of the year after the year of the account holder’s death, or over a period of five years.  
  • Take a lump sum distribution. You may owe income taxes on the money, but you won’t have to pay the 10 percent early withdrawal penalty. You might want to investigate the tax consequences of this action first, as it could push you into a higher tax bracket for the year you take the distribution.

What about Roth IRAs?

If you inherit a Roth IRA (which consists of after-tax contributions, not pre-tax contributions as with a regular IRA), the options are the same, except you generally do not have to pay taxes on the withdrawals. An exception is if the account is less than five years old, in which case you have to pay taxes on the earnings.

What to do if you inherit an IRA

The Financial Industry Regulatory Authority recommends the following steps if you inherit a traditional or Roth IRA.

  • Contact the firm that operates the account to notify them of the account holder’s death.
  • Provide all documents requested.
  • Spouses who decide to treat the IRA as their own should decide if they want to keep the account at that firm, or switch to another.

One other consideration

In rare cases, some people decide not to claim the IRA at all, or only claim part of it. This may be done for tax purposes or so that someone else will inherit the account, but anyone considering this should consult with an attorney to make sure it’s done correctly. This action must be taken within nine months of the account holder’s death and must be in writing. Your state may have certain guidelines you must follow, in addition to federal rules.

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