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What is an Inherited IRA?

Money Manager | Monday, October 11th, 2010

The term “inherited IRA” is used to refer to an individual retirement account (IRA), which after the owner’s death, is left to one of his or her beneficiaries. The tax laws for IRA plan inheritance can be quite complicated for the average person to figure out. Because of this, it is generally recommended that any beneficiaries who inherit an IRA seek out the counsel of a tax professional or financial advisor. The overall laws and tax laws that govern IRA plans also tend to change over time, so it’s important to understand how these laws affect any IRA money that is inherited.

How are plan distributions handled when one inherits an IRA?

The handling of plan distributions can vary, depending on the scenario that existed at the time of death. If payments had already begun to be made to the owner, the distribution of funds will continue in the same way, according to the original calculations. The beneficiary could also submit a new distribution schedule, which would be based on the beneficiary’s own life expectancy. If the owner had not yet reached the age of 70-1/2 years, or if they hadn’t yet set up a schedule for the distribution, then the beneficiary has five years in order to withdraw the funds from the IRA plan. At the time the money is withdrawn, the funds will be subject to standard income taxes. If the owner’s spouse inherits the IRA, he or she can roll the funds over into their own IRA account, without having to pay any kind of penalties. However, this scenario only applies to the owner’s spouse, and not to any other beneficiaries. Non-spousal beneficiaries can receive the money spread out over their own life expectancy, which will help to spread out the tax liability for the money that was inherited from the IRA.

What is the process for leaving an IRA plan to a beneficiary?

Many people leave their IRA accounts to their spouse. In some cases, the spouse may find that they really do not need these assets. However, by leaving the IRA to a spouse, they are free to make the decision as to whether they take ownership of the assets or not. If they do not, the assets can then be passed to other beneficiaries that may be named. It is also possible to make a child, grandchild or even another individual the primary beneficiary instead of the spouse. Depending on that person’s age, they are likely to be able to spread the distributions out over an even longer period of time, since their life expectancy may be longer than that of the owner’s spouse. This will reduce the amount of the individual distribution payments, which will leave more money in the IRA for a longer period of time. This will give the money more time to grow, while remaining tax-deferred. Choosing a beneficiary for an IRA can be a complicated decision. If you have any questions or concerns about choosing a beneficiary, it can be helpful to consult a financial advisor or attorney.

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