If you have a spouse or a relative with an IRA, you may be curious about what an inherited IRA is. This is also a common question if you have been named a beneficiary of the account. Read on to lean more about the non-spousal and spousal rollover rules as well other important information about Inherited IRAs.
What Is An Inherited IRA? | Learning the Rules
In This Article:
- What Is an Inherited IRA?
- Inheriting an Inherited IRA from a Parent
- Inheriting an IRA from a Spouse
- Limitations and Rules for an Inherited IRA
- Inherited IRA IRS Rules and Standards
What Is an Inherited IRA?
Inheriting an IRA from a parent, a spouse or a loved one leaves you with questions: What is an inherited IRA? How much tax on inherited tax is there? What are the tax implications? What are the beneficiary IRA rules?
An inherited IRA or beneficiary IRA is an individual retirement account (IRA) “opened” when a parent, spouse, or an unrelated person names you as the beneficiary of their account. It kicks in once the original owner dies.
There are many advantages of an inherited IRA. For one, an inherited IRA can become almost any IRA type. These include Traditional IRA, Roth IRA, and even an employer-sponsored plan.
With an inherited IRA, it is usually the spouse or the children who become beneficiaries. It is not uncommon, though, to have an inherited IRA with multiple beneficiaries. They may even be unrelated individuals, an estate, or a trust.
The inherited IRA rollover rules may provide the same tax benefit. It is also possible to defer the tax payment. This makes it ideal to pass the inheritance as cheaply as possible. Not knowing the rules, though, can be dangerous. The effect may be opposite. It is important to note that the account triggers tax responsibility.
Inheriting an Inherited IRA from a Parent
For those with IRAs, including inherited, one of the significant concerns is taxes. Taxes on the account depend on the situation and your relation to the original account holder.
Inheriting an IRA from a parent or a third party means you have a non-spouse IRA. An inherited IRA non spouse account has specific standards for your withdrawal rate. You must withdraw the money from the account on a certain date.
Cashing out an inherited IRA allows you to use the money in the account. You can set up a withdrawal plan when you open the inherited IRA account. You have three options. These are lump-sum withdrawal, life-expectancy withdrawal, or five-year withdrawal.
A lump-sum withdrawal plan means you take out the entire amount in the account. The benefit of a lump-sum withdrawal is its simplicity. You can take out the money after transferring the IRA into your name.
Life-expectancy withdrawal plans start at December 31 on the year the account holder passed away. This type of plan uses an inherited IRA calculator to determine your withdrawal rate.
You start taking out the money each year based on your life expectancy. A required minimum distribution (RMD) applies to a Traditional IRA account. You must withdraw the RMD even if an inherited IRA calculator suggests you have a longer life expectancy.
A five-year withdrawal plan starts at December 31 after a loved one dies. You calculate your withdrawal rate over a five-year period. The amount you receive depends on the money in the account.
In a Traditional IRA, you have to wait until you are 59.5 years old to make your first withdrawal. Otherwise, withdrawing the money prematurely can result in a 10 percent penalty. This rule does not apply to inherited IRA non spouse accounts.
Inheriting an IRA from a Spouse
An inherited IRA spouse account has rules similar to those of a non-spouse account. You can transfer the account into an inherited IRA account. The options available are also the same. You can also withdraw the money without a 10 percent penalty if you are under 59.5 years old.
The main difference is the fourth plan. As a spouse, you can roll the IRA funds into your retirement account. A spousal transfer means you put the money into your IRA account and treat it like your retirement plan. Note that doing this may prevent you from withdrawing the money before 59.5 years old unless you want to pay the penalty.
Limitations and Rules for an Inherited IRA
Inherited IRA accounts have limitations and rules to consider. One of these is the age of the account holder upon death. If they were 70.5 years old or older during their demise, you cannot set up a five-year withdrawal plan. You choose between a lump sum or life-expectancy inherited IRA account.
Another is the RMD, which is the lowest amount you can withdraw for a year after the holder passes away. If you do not take out the RMD by December 31 of the year the person died, you may have to pay a penalty of 50 percent. If you inherit the account from a parent or non spouse, find out if your loved one took out the RMD before they passed away to avoid a penalty.
Inherited IRA IRS Rules and Standards
Taxes are a key consideration when you inherit a retirement account. Inherited IRA IRS rules and standards depend on the type of IRA you receive. Look up the type of account before you take out any funds.
If you inherit a Traditional IRA or a tax-deferred account, then you must pay taxes when you take out the money. The downside of a lump-sum withdrawal plan in a tax-deferred account is the cost. You may increase your tax bracket and pay the capital gains taxes. If you set up a life-expectancy withdrawal plan, then you pay taxes on the amount you take out.
A Roth IRA account does not always have tax penalties. If a loved one opened the account five years before their death, then you do not pay taxes on the money. If the account was not five years old, then you pay taxes on the earnings. Fill out the 1099-R and the 5498 forms when you file your taxes.
What is an inherited IRA? Consider it the parting gift from an IRA account holder to you. It boosts either your retirement account, your wealth, or both. While it offers many benefits, it also introduces responsibilities. These include knowing the laws and the consequence of your chosen withdrawal plan.
Do you have other questions about inherited IRA? Leave them in the comments section below.