Inheriting money or assets from someone is a wonderful gift, but when it comes to certain types of retirement accounts (like IRAs) there are different rules for beneficiaries. The IRS has specific rules that determine what beneficiaries can do with the inherited IRA and how they must take distributions from it. The rules for inherited IRAs depend on the relationship to the person who owned the IRA and the type of IRA it is. For those looking to learn about inheriting an IRA, Trajan Wealth is here to teach you what you need to know.
Traditional IRA Required Minimum Distributions
As a non-spouse beneficiary, it’s essential to understand the rules for Required Minimum Distributions (RMDs) from an inherited IRA. If you inherit an IRA, you generally must start taking RMDs by December 31st of the year following the original owner’s death. The RMD amount is based on your age and life expectancy, providing you with the option to take distributions over your life, unless the “5 year rule” is enacted.
- Under the ‘5-Year Rule,’ you have the flexibility to take distributions over five years so that all assets are liquidated from the inherited IRA by the 5th anniversary of the original owner’s death.
- With either distribution option, the 10% early withdrawal penalty typically imposed by the IRS does not apply if you are not yet 59 ½ years of age. However, if you fail to take a distribution, the IRS will enforce a substantial 50% penalty on the amount you should have withdrawn at tax time.
- Furthermore, traditional IRAs are taxed upon distribution at the owner’s tax rate, which includes contributions and accumulated earnings. Understanding these rules is crucial for managing an inherited IRA and avoiding potential penalties.
Roth IRA Required Minimum Distributions (RMD)
Though Roth IRAs are not subject to Required Minimum Distributions (RMD) for the original owner, it’s important to note that when Roth IRAs are inherited, RMDs do apply.
- RMD is calculated based on the beneficiary’s age and life expectancy. The IRS provides tables and guidance for these calculations.
- In the case of inheriting a Roth IRA, you can use the 5-year rule to take distributions over a 5-year period, ensuring that all assets are liquidated from the IRA by the 5th anniversary of the original IRA owner’s death.
- It’s crucial to adhere to the distribution requirements, as failing to take a distribution can result in a significant penalty. The IRS may apply a 50% penalty on the amount that should have been distributed at tax time.
- One key benefit of inheriting a Roth IRA is that all distributions are tax-free for the beneficiary. This means the beneficiary can completely liquidate the Roth IRA with no taxes due, providing an advantageous financial opportunity.
Inherited IRAs with Multiple Non-Spouse Beneficiaries
When dealing with inherited shares, it is crucial to ensure that they are separated from other beneficiaries. Ownership should be formally transferred to the name of each beneficiary with the IRA custodian to avoid any confusion or complications.
It is important to note that the same required minimum distribution (RMD) rules apply, regardless of whether they are based on life expectancy or the 5-year rule. If ownership of the inherited shares doesn’t transfer, the RMDs will be calculated based on the age and life expectancy of the oldest beneficiary.
Inherited IRAs Can’t be ‘Rolled Over’ to a New IRA
When you inherit a Traditional IRA, it’s crucial to handle the change of ownership correctly. To avoid penalties and taxes, it’s important to ensure that the IRA remains intact during the transfer process. As the beneficiary, it’s recommended to promptly contact the custodian of the IRA to receive detailed instructions and the necessary paperwork to initiate the ownership transfer. This will help ensure a smooth and compliant transition of the IRA ownership.
Reach Out to Trajan Wealth for Assistance with Your Inherited IRA
If you have any questions or concerns regarding inherited IRAs as part of your legacy planning for your heirs, or if you foresee inheriting an IRA, reach out to Trajan Wealth.
