Inheriting an IRA!

(This information is for educational purposes only and not to be considered as Legal or Tax Advice.)

If you inherit a traditional IRA, it is subject to special rules. According to IRS

http://www.irs.gov/pub/irs-pdf/p590.pdf  

The beneficiaries of a IRA must include in their taxable gross income any distributions they receive for 

a traditional, SEP, SIMPLE, or Traditional IRA.

Beneficiaries. The beneficiaries of a traditional IRA can include an estate, dependents, and anyone 

the owner chooses to receive the benefits of the IRA after he or she dies.

Inherited from a spouse. 

If you inherit a traditional IRA from your deceased spouse, you can generally roll it over into another 

traditional IRA established for you or you can choose to treat the inherited IRA as your own. You can 

choose to treat it as your own by designating yourself as the account owner rather than the beneficiary. 

For a good explanation of what is a "rollover" GO HERE

You will be considered to have chosen to treat it as your own if:

• Contributions (including rollover contributions) are made to the inherited IRA, or
• Required distributions are not made from it.

You will only be considered to have chosen to treat it as your own if:

• You are the sole beneficiary of the IRA,
• You have an unlimited right to withdraw amounts from it, and

·         The distribution of the required minimum amount for the account for the calendar year of 

            the decedent's death has been made.

For distributions after December 31, 2001, your rollover options increased. You may still roll over 

your spouse's IRA into your own traditional IRA, but all "distributions" are taxable, meaning if 

you actually take money out of it.

NOTE: if you make distributions from an IRA that are used for higher education purposes for yourself 

for someone directly related to you, the maximum distribution of $10,000 is NOT subject to a early 

withdrawal penalty. Or if you use the $10,000 distributions to buy, build, or rebuild a first home.

You can also roll it over into your qualified plan, your qualified employee annuity (section 403(a) annuity), 

your tax-sheltered annuity (section 403(b) annuity), or your deferred compensation plan of your state 

or local government (section 457 plan). For a good explanation of what is a "rollover" GO HERE

You cannot keep amounts in your traditional IRA indefinitely. Generally, you must begin receiving 

distributions by April 1 of the year following the year in which you reach age 70 1/2 (your 70 1/2 year). 

The minimum required distribution for any year after your 70 1/2 year must be made by December 31 

of that later year.

Tax on excess. If distributions are less than the minimum required distribution for the year, discussed 

earlier under RMD (Required Distributions), you may have to pay a 50% excise tax for that year on 

the amount not distributed as required.

Surviving spouse. If the designated beneficiary is the owner's surviving spouse, and he or she dies 

before he or she was required to begin receiving distributions, the surviving spouse will be treated as 

if he or she were the owner of the IRA. If you have inherited an IRA from someone who has already 

started taking Required Minimum Distributions it could provide you with a substantial tax deduction. 

Read the next paragraph.

Federal estate tax deduction. A beneficiary may be able to claim a deduction for estate tax resulting 

from certain distributions from a traditional IRA. The beneficiary can deduct the estate tax paid on any 

part of a distribution that is “income in respect of a decedent”. He or she can take the deduction for 

the tax year the income is reported.

Inherited from someone other than a spouse. 

See IRS rules http://www.irs.gov/

Beneficiary other than spouse. If you inherit a traditional IRA from someone other than your spouse, 

you cannot treat it as your own IRA. You cannot rollover any part of it or roll any amount over into it. 

You cannot make any contributions to an inherited traditional IRA.

If you inherit a traditional IRA from anyone other than your deceased spouse, you can NOT treat the 

inherited IRA as your own. This means that contributions (including rollover contributions) cannot be 

made to the IRA and you cannot rollover any amounts out of the inherited IRA. But, like the original 

owner, you generally will not owe tax on the assets in the IRA until you receive distributions from it. 

(This same rule applies to almost any type of qualified retirement plan: 401k, 403(b), TSA account, 

457 plans and others that are similar tax-deferred retirement plans.)

You must begin receiving distributions from the IRA under the rules for distributions that apply to 

beneficiaries. 

If the previous IRA owner dies before distributions have begun, the following rules will generally apply 

for most people.  The entire IRA must be distributed under one of the following two rules:

·         Rule 1. By December 31 of the fifth year following the year of the owner's death.

·         Rule 2. Over the life of the designated beneficiary or over a period not extending beyond 

                        the life expectancy of the designated beneficiary. See Table I (Single Life Expectancy) 

                  (For Use by Beneficiaries) in Appendix C. (see IRS codes and tables)

The terms of the traditional IRA can specify whether Rule 1 or 2 applies, or they can permit either 

the owner or beneficiary to choose which rule applies. If the owner or beneficiary can choose which 

rule applies, the choice must generally be made by December 31 of the year following the year of the 

owner's death. This is because distributions generally must begin under Rule 2 by that date. Under 

Rule 2, at least a minimum amount must be distributed each year.

No rule specified or chosen. If no rule has been specified or chosen, distribution must be made 

under Rule 2 unless Rule 1 applies. Rule 1 only applies if no beneficiary is designated by the end 

of the year following the owner's year of death.

Rule 2 picked and spouse is not the beneficiary. If Rule 2 has been specified or chosen and 

the beneficiary is not the surviving spouse, distribution must begin by December 31 of the year 

following the year of the owner's death.

Rule 2 picked and spouse is the beneficiary. If Rule 2 has been specified or chosen and the 

beneficiary is the surviving spouse (and he or she did not choose to treat the IRA as his or her 

own), distribution must begin by the later of the following two dates.

·         December 31 of the year the IRA owner would have reached age 70 1/2.

·         December 31 of the year following the year of the owner's death.

Multiple individual beneficiaries. If as of the end of the year following the year in which the 

owner dies there is more than one beneficiary, the beneficiary with the shortest life expectancy 

will be the designated beneficiary if both of the following apply.

1.      All of the beneficiaries are individuals, and

2.      The account or benefit has not been divided into separate accounts or shares for each 

beneficiary.

A beneficiary who is an individual can elect to take the entire account by the end of the fifth year 

following the year of the owner's death. If this election is made, no distribution is required for any 

year before that fifth year. However, a distribution  is allowed to be distributed if desired by the 

beneficiary during this same five year period. If you are an individual figuring your first distribution 

by your required beginning date, use your age as  of your birthday in the year distributions must begin. 

This is usually the calendar year immediately following the calendar year of the owner's death.

More than one IRA. If you have more than one traditional IRA, you must determine the minimum 

required distribution separately for each IRA. However, you can total these minimum amounts and

take the total from any one or more of the IRAs.

Installments allowed. The yearly minimum required distribution can be taken in a series of installments 

(monthly, quarterly, etc.) as long as the total distributions for the year are at least as much as the 

minimum  required amount. 

NOTE: if you do take distributions from an inherited IRA, and you are not age 59 1/2 yet, 

you are NOT  obligated to pay the additional IRS early withdrawal penalty.

Here is an explanation of one of the best ways to handle moving the money from the old IRA to you, 

the new owner (the beneficiary):

a) first, you want to contact the company where the IRA (or 401k, 403(b)) is at and tell them you 

are the beneficiary and that you want to move it. (They will send you some forms to sign)

b) second, find a good company to move it to (such as a mutual fund or annuity company).

Once you've selected WHERE to move it to. Tell that company you want to establish a "beneficiary 

IRA" to move the money into. This keeps the money in the name of the person it used to belong to, 

however, it also allows you "the beneficiary" to have control of it and also allows you to manage how

it is invested during the distribution phase.

c) you will also want to establish with the new company, what is called a non-qualified account, in 

our name, with you as the owner. If you chose an annuity company, this would be called a non-qualified 

variable annuity, for example. Then you will have an account to move your money into, when it comes 

out of the IRA account of the previous persons name.

d) if you want to put some of the money into (in this example an annuity) and you also want to use 

part of the money for something else (for more immediate uses) then you might open a Money Market 

somewhere to move that part of the money you want to use in the near future. This will be a good 

place to hold it until you're ready to actually use it.

The above plan works well for those who want to spread out the distributions over, let's say a five 

year distribution, such as using the Rule 2 described above. It also works for anyone taking a lump 

sum distribution as well. At least you'll have a good place to invest the money for tax-deferred growth.

Why spread out the distributions over 5 years?

You may save yourself some income taxes if you transfer the money over the 5 years. Here's why: 

For illustration purposes only:

Let's say you already earn $100,000 a year in income and are in a 27.5% tax bracket. Now you 

inherit an IRA for let's say $300,000, which can be distributed over 5 years. Remember, this IRA 

distribution is going to be added to your other earned taxable income and you'll pay income taxes 

on all of it. This, in MOST cases, will put you in a much higher tax bracket. For example, if you 

took the whole $300,000 all at once, added to your

earned income of $100,000, now you will pay taxes on $400,000 in one year, which puts you in 

the 39.1% tax bracket (the highest!) This also means you are now paying 39.1% taxes on your 

original $100,000 of earned income as well! In this example your inheritance of $300,000 would 

shrink to a (net after tax amount) of $182,700! Plus your earned income would also shrink to a 

(net after tax amount) of $60,900!

However, if you use the five year distribution method available to you, here is how it might look 

instead. Divide the $300,000 by 5= $60,000. By taking the $60,000 distribution each year and 

adding that to your earned income of $100,000 for the total of $160,000 puts you in the 30.5% 

tax bracket. You've just saved 8.6% in taxes on the full $300,000, which is approximately 

$25,800 in tax savings!

Remember, the "beneficiary IRA" account is still your money and with this method you will still have 

control of the money and control how it is invested. You just haven't moved it into your own name 

yet or paid the taxes on it yet. Who knows, if your lucky and that money continues to grow (while 

still being in the old IRA) you could improve upon this scenario even further. PLUS, each year you 

will be moving some of it into your own account (preferably tax-deferred) and making it grow as 

well. For details on a possible place to invest your inherited money GO HERE. If you'd like some 

help or have questions drop me a note or ask me your question Got a Question? 

For information on "STRETCH IRA's" e-mail me or use my Got a Question?   I can show you some 

of the BEST ways to use your IRA money to it's fullest advantage!

Reporting Additional Taxes

Generally, you must use Form 5329 to report the tax on excess contributions, early (premature) 

distributions, and excess accumulations. Filing Form 1040. If you file Form 1040, complete Form 

5329 and attach it to your Form 1040. Enter the total amount of IRA tax due on line 55, Form 1040. 

Note. If you have to file an individual income tax return and Form 5329, you must use Form 1040.

Please, consult a Tax Attorney or CPA for your individual/specific Tax situations.  

List of my Financial Services

Complete INDEX of articles 

DISCLAIMER: I am NOT an attorney, nor a CPA, and this information is NOT to be mistaken 

for giving legal or tax advice. I am merely providing information that has been provided to me 

from what is deemed to be reliable sources and adding my own comments to that information, 

hopefully for a better understanding.