Inherited IRA: What Beneficiaries Need to Know

Inherited IRA

Inherited IRA

When a person sets up an IRA account, he or she will be able to choose succeeding beneficiaries. These designated beneficiaries will be the ones who can claim whatever is left in the IRA account when the account holder passes away.

An inherited IRA is a great way for a spouse to leave his or her assets to the other spouse, to their children or other family members. When receiving the IRA, however, the beneficiaries need to know their options.

Spouse Beneficiaries

Spouse beneficiaries have the most flexible options when it comes to receiving and distributing an inherited IRA.

Their first option is to withdraw the entire amount left in the IRA, which is often not recommended because of the expensive income tax. They can also opt to spread the distribution over their lifetime in order to lower the immediate tax bills.

As a spouse, however, the beneficiary also has another option of treating the IRA as their own. This means, they can leave the money to grow, without taking any distribution, until they reach the age of 70 ½. The spouse can also roll over the inherited IRA into a retirement account of their own. With this option, however, if they make any withdrawal before their retirement age, an early withdrawal fine will apply.

Non-Spouse Beneficiaries

Beneficiaries that are not the spouse of the deceased person do not have the option of treating the inherited IRA as their own.

They can either withdraw the entire amount within 5 years, or spread it out over their lifetime.

Even when the beneficiary chooses to spread the distributions over their life time, he or she is still required to make a minimum distribution every year by December 31st of that year. The exact minimum amount is calculated based on the beneficiary’s life expectancy. You can calculate the exact required distribution using this calculator. Income taxes will still apply on this minimum distribution. However, there is no early withdrawal penalty, even if the beneficiary is less than 59 ½ years of age.

By spreading out the distributions, the beneficiaries of inherited IRAs will be able to spread out the tax payments, and allow the IRA to continue to grow on a tax-deferred or tax-free basis.

Inherited IRA: Self-directed Option

Spouse and non-spouse beneficiaries both have the option of transferring money into a self-directed Inherited IRA.

For non-spouse beneficiaries, the Required Minimum Distribution still applies. However, they can keep the rest of the money invested within the Inherited IRA on a tax-free or tax-deferred basis.

Spouse beneficiaries may want to transfer the money into an Inherited IRA instead of their personal IRA, so that they can start withdrawing the money before the age of 59 ½ without subjecting to the 10% early withdraw penalty.

For either group, having a self-directed Inherited IRA opens up other investment possibilities. Just like any other Checkbook IRA, a self-directed Inherited IRA is allowed to invest in more than stocks and mutual funds. The beneficiaries can act without getting approval from the custodians. Their investment options now include real estate, private businesses, precious metals, and much more.