Did you inherit an IRA? This is what you need to know | personal finance

(Stefon Walters)

The rules surrounding an inherited IRA are a bit more complicated than the ones you encounter when you open and fund your own account, and which ones will apply largely depend on what category of beneficiary you fall into: spouse, child, or not a spouse, or an entity such as an estate or charity. Each of these groups has its own set of rules about taxes and withdrawals. If you inherited an IRA, here’s what you need to know.

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Inheriting an IRA from a spouse

Inheriting an IRA from a spouse is the simplest of the three scenarios. As your widow or widower, you can change the title of the IRA to her name or transfer the money to a new IRA.

If it’s a Roth IRA, you can withdraw any funds tax-free if the account has been in existence for at least five years. If five years haven’t passed, you’ll have to wait until then to make tax-free withdrawals. Rolling over an inherited IRA into a new or existing Roth IRA is a good approach for anyone who doesn’t want to take money out of the account and would rather let it continue to grow and compound.

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For a traditional IRA, the inheritance rules are slightly different. You can withdraw all of the money, but you will have to pay income taxes on the full amount. You can also transfer the funds from the legacy IRA to your own traditional IRA, but you’ll have to do the typical RMDs. If you are not 59½ and you make a withdrawal, you will be subject to a 10% early withdrawal penalty.

Inheriting an IRA as a non-spouse or entity

If you inherit an IRA from a parent or other family member, you won’t be able to retitle it in your own name, but you will have the option to transfer the funds to a new account. You can also collect the full amount as a lump sum distribution. If it’s a Roth IRA, the withdrawal will be tax-free as long as the account is at least five years old. If it’s a traditional IRA, you’ll pay income taxes on the funds you withdraw.

With traditional IRAs, non-spouse beneficiaries cannot make contributions to the legacy IRA or roll any amounts into or out of the legacy IRA. However, the beneficiary may make a trustee-to-trustee transfer as long as the IRA to which the amounts are transferred is established and maintained as an inherited IRA in the name of the deceased IRA owner for the benefit of the beneficiary.

Non-spouse beneficiaries generally must withdraw the full amount of their inherited IRA within 10 years of the original owner’s death. There are exceptions for minor children of a deceased person and those who are less than 10 years younger than the deceased. In those cases, heirs could take required minimum distributions (RMDs) based on their life expectancy.

Seek help if needed

The rules around legacy IRAs can be confusing to navigate, but getting clarity on them can help you avoid unexpected tax bills or penalties. If you feel overwhelmed with the various options, don’t hesitate to seek help from a professional who can make sure you understand all the implications of your choices. That could save you a lot of headaches and potentially a lot of money.

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