What is the Best Thing to Do With an Inherited IRA?

When inheriting an IRA, it’s essential to fully comprehend your options as the decisions may have significant tax repercussions.

Your options depend on your relationship to and age of death of the original owner, but generally speaking they include:1. Create an inherited IRA

Determine your relationship to the original owner.

What you do with an inherited IRA depends on how closely related you are to its original owner and when required minimum distributions should commence. Surviving spouses have one set of options while minor children, disabled beneficiaries or those within 10 years younger are subject to another.

Non-spouse beneficiaries must liquidate an inherited IRA within 10 years of its original account owner’s death, but they have options for doing so more gradually or rolling it into their own IRA, giving them more control and potentially helping avoid penalties.

Determine your distribution options.

Inherited IRAs contain specific rules that dictate how the funds can be distributed; spouse beneficiaries have one set of options while non-spouse beneficiaries have another.

The easiest and most straightforward solution is to add any inheritance assets you receive to an existing retirement account in your name, where they’ll remain tax-deferred until withdrawal in retirement. However, doing this may increase overall taxable income and should therefore be taken into consideration carefully.

Opting for a lump-sum distribution provides immediate access to funds but may incur a large income tax bill. Before considering this route, consult with an experienced financial or tax specialist and weigh all available options before making your decision. For instance, taking small distributions over 10 years could help minimize taxable income and prevent penalties.

Take a lump-sum distribution.

Beneficiaries may withdraw the contents of an inherited IRA all at once, increasing taxable income and forgoing potential tax-deferred growth. It’s usually only recommended if they need the funds immediately such as in cases involving widowed spouses or those under 59 1/2 who require instantaneous access.

Gibson notes that beneficiaries may choose to roll an IRA into their own accounts and use their own life expectancy for RMD calculations, rather than that of the original account owner. They must complete this transfer by Dec 31 of the year following the death.

An inherited IRA can be complex, so it’s wise to consult a financial planner or estate-planning attorney prior to making any decisions about its investments. A professional can ensure your IRA fits with your goals and objectives.

Roll the contents into an existing IRA.

Your required minimum distributions could be stretched by rolling over an inherited IRA into an account in your name, potentially helping to avoid incurring tax penalties for taking out too much at once.

Funds that remain taxable under current rules will still be subject to distribution regulations and any applicable 10% income-tax penalties for early withdrawals, according to Choate. Beneficiaries should consult with a tax advisor before considering this option.

Choate suggests another effective method for rolling over an inherited IRA is by moving it directly from its financial institution to yours, notes Choate. Doing this allows you to use your own life expectancy when calculating RMDs rather than that of the deceased spouse, potentially helping stretch out distributions more slowly.

Disclaim the inheritance.

Dependent upon the type of IRA and your relationship to the deceased, there are various methods available for you to claim an inheritance. Each approach comes with its own set of regulations, so it is advisable to seek professional advice prior to choosing one of them.

A lump-sum distribution is often the easiest and quickest way to access an inheritance quickly, though this also means paying income tax on such a large sum all at once.

Rolling the contents into your existing IRA may also be an option; this works especially well if you are over 59 1/2 and therefore won’t incur the 10% early withdrawal penalty. To do this, request a trustee-to-trustee transfer from the original institution to your account.

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