Five Things to Know About Inherited IRAs

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When an IRA owner dies, the IRA proceeds are payable to the named beneficiary — or to the owner’s estate if no beneficiary is named. If you’ve been designated as the beneficiary of a traditional or Roth IRA, it’s important to understand special rules that apply to “inherited IRAs.”

It’s not really ‘your” IRA
While you have certain rights, you generally aren’t the “owner” of an inherited IRA. This means you can’t mix inherited IRA funds with your own IRA funds, and you can’t make 60-day rollovers to and from the inherited IRA. You also need to calculate the taxable portion of any payment from the inherited IRA separately from your own IRAs, and you need to determine the amount of any required minimum distributions (RMDs) from the inherited IRA separately from your IRAs.

However, if you inherited the IRA from your spouse, you have special options. You can take ownership of the IRA funds by rolling them into your own IRA or into an eligible retirement plan account. If you’re the sole beneficiary, you can also leave the funds in the inherited IRA and treat it as your own IRA. In either case, the IRA will be yours and no longer treated as an inherited IRA. As the new IRA owner (as opposed to beneficiary), you won’t need to begin taking RMDs from a traditional IRA until you reach age 701/2 and you won’t need to take RMDs from a Roth IRA during your lifetime at all. You can also name beneficiaries of your choice.

Required minimum distributions
As beneficiary of an inherited IRA — traditional or Roth — you must begin taking RMDs after the owner’s death. In general, you must take payments from the IRA annually, over your life expectancy, starting no later than December 31 of the year following the year the IRA owner died. But if you’re a spousal beneficiary, you may be able to delay payments until the year the IRA owner would have reached age 701/2.

In some cases you may be able to satisfy the RMD rules by withdrawing the entire balance of the inherited IRA by the fifth anniversary of the owner’s death. In almost every situation, though, it makes sense to use the life expectancy method instead — to stretch payments out as long as possible and take maximum advantage of the IRA’s tax-deferral benefit.

Federal income taxes
Distributions from inherited IRAs are subject to federal income taxes, except for any Roth or nondeductible contributions the owner made. But distributions are never subject to the 10% early distribution penalty, even if you haven’t yet reached age 591/2. (This is one reason a surviving spouse may decide to remain as beneficiary rather than taking ownership of an inherited IRA).

When you take a distribution from an inherited Roth IRA, the owner’s nontaxable Roth contributions are deemed to come out first, followed by any earnings. Earnings are also tax-free if made after a five-calendar-year holding period, starting with the year the IRA owner first contributed to any Roth IRA.

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2016.

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