Five Rules for Inherited IRAs

by Norris Law Group on November 27, 2014

Did you know that the tax liabilities on inherited IRA accounts may be stretched out for years, even decades, after inheritance? This is just one feature of inherited IRAs about which account holders and heirs may not be aware. They may also not know that the manner in which beneficiary forms are filled out can have a major impact on how inherited IRAs can be handled. Attorney and journalist Deborah Jacobs discusses these and other aspects of inherited IRAs in an article that appeared in Forbes magazine titled Five Rules for Inherited IRAs.

  1. “First, do no harm.” If you inherit an IRA account, do nothing until you are certain you are sure of all the rules that apply. For example, if you move a personal IRA from one IRA account to another within 60 days without incurring a penalty. Moving funds from an inherited IRA account to another account is different. Money moved from one IRA custodian to another must be done in a “trustee to trustee transfer,” and the IRA must be renamed. IRAs that are split between parties must be split into separate IRAs.
  2. “Beneficiary forms rule.” Speak with the custodian of your IRA accounts to get very specific information about how to fill out your beneficiary forms so that your wishes for distributing the IRAs to your heirs will be carried out properly. If no beneficiaries are names, distribution is subject to the rules of the IRA custodian’s existing policies. These rules usually mandate distribution to a living spouse and then to an estate.
  3. “Employer plans are different.” Federal law requires that 401(k) funds must be distributed to a spouse, unless he or she has waived rights to it by signing a form. Some 401(k) plans will allow distribution to children if there is no spouse and no beneficiary form on file, but inheritors usually cannot stretch out tax liability on 401(k) distributions. Contact your individual 401(k) administrator for more information.
  4. “Spouses have more options.”  A spouse can roll assets into a personal IRA and postpone distributions from a traditional IRA until he or she turns 70 1/2. The 10% tax early-withdrawal penalty would still apply if money is taken out before the spouse turns 59 1/2, but he or she would not have to withdraw funds until the late spouse from whom the IRA was inherited would have turned 70½.
  5. “Watch for distribution traps.” If the owner of an IRA passes away after he or she is 70½ or older, beneficiaries must ensure that the late owner’s yearly distribution was deducted for the year of death before they can do anything else. “Non-spouse” beneficiaries should be aware of two things:
    1. If the estate of the deceased IRA holder had to pay estate tax, beneficiaries may be able to use itemized deductions to counteract some of the IRA income.
    2. Minimum distributions are calculated differently than they would be on your own IRA. Take the balance on Dec. 31 of the previous year and divide it by your life expectancy listed in the IRS’ “single life expectancy” table, rather than the table used by the original owner of the IRA. The following year, use the same life expectancy and deduct a year. You would take a new life expectancy from a table each year when dealing with your own IRA.

Attorney Graham Norris and his associates at the Norris Law Group serve the residents of Utah County, UT and throughout Utah, Wyoming and Idaho. Contact them today at 801-932-1238 or online for a free consultation.

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