Distribution Rules for an Inherited IRA

Distribution Rules for an Inherited IRA
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Transferring the Balance

Moving the balance from the inherited account to an account of your own isn’t as simple as a traditional transfer. All movement has to move via a trustee-to-trustee transfer from one IRA custodian to another. If you get a check with the IRA proceeds instead, the Internal Revenue Service taxes it as ordinary income. IRAs not inherited from a spouse must be renamed and retitled. The newly titled IRA must include the original owner’s name and an indicator that it has been inherited, such as "Richard Roe (deceased Dec. 31, 2014) IRA for the benefit of Angela Roe." If a single IRA has multiple beneficiaries, the custodian should split it into separate IRAs.

Spouse Options

If you’re inheriting a traditional IRA from your spouse and the account holder was younger than 70 1/2 when he died, you can transfer the assets into your own IRA. This new IRA can be an existing one or a new one set up for that purpose, as long as you’re the sole beneficiary. You also can use the funds to open an inherited IRA using the life expectancy method. If you do, withdrawals must be made by Dec. 31 of the year the original account holder would have turned 70 1/2. Another option is to open an inherited IRA using the five-year method, which requires funds to have been fully distributed five years after the original account holder dies. You can also take a lump sum distribution of the assets. If the account holder was older than 70 1/2, the five-year method is not an option.

Non-Spouse Beneficiaries

Non-spouses have options similar to those of spouses, except that you can’t transfer the assets to your own IRA. Funds from an inherited IRA from an account holder younger than 70 1/2 can be placed in IRAs using the life expectancy or five-year methods. You can also take a lump sum distribution. With that option, you’ll pay taxes on the distribution but not the early withdrawal penalty. IRAs from those older than 70 1/2 can’t be transferred to an IRA using the five-year method.

Roth IRAs

The process for transferring Roth IRAs is similar to the process with other IRAs. Spouses can transfer to their own existing or new IRAs. Both spouses and non-spouses can also use the life expectancy or five-year methods based on the age of the deceased, or they can elect a lump sum distribution. The big difference is how the funds are treated by the IRS, as Roth IRA distributions generally are tax free. However, if the account was less than five years old at the time of the original account holder's death and a lump sum distribution is selected, the earnings are taxable.