What else not to do: Don’t name your estate as your IRA beneficiary (also important to note: if you DON’T name a beneficiary, your estate becomes the default). Typically, nonspouse beneficiaries who inherit a traditional IRA can either liquidate and pay taxes on those assets within five years of the owner’s death, or take the so-called “stretch option” and stretch the required minimum distributions out over their own lifetime. This could amount to thousands of dollars of lost growth. On top of that, if the IRA becomes part of your estate and enters probate, it can be accessed by creditors.
Has anyone seen that form? Do you know where your IRA beneficiary form is? Don’t assume it’s easily accessible from your broker or bank, because with all the mergers and acquisitions over the last decade, paperwork may have become lost in the shuffle. So, find that piece of paper — and all your important financial documents — and secure them. Then, tell your attorney and your family members where you have stored them.
Inheriting an IRA as a spouse
According to the IRS, if you inherit a traditional IRA from your spouse, you generally have the following three choices. You can:
Treat it as your own IRA by designating yourself as the account owner.
Treat it as your own by rolling it over into your IRA, or to the extent it is taxable, into a:
Qualified employer plan,
Qualified employee annuity plan (section 403(a) plan),
Tax-sheltered annuity plan (section 403(b) plan),
Deferred compensation plan of a state or local government (section 457 plan), or
3. Treat yourself as the beneficiary rather than treating the IRA as your own.
If you treat it as your own
You will be considered to have chosen to treat the IRA as your own if:
Contributions (including rollover contributions) are made to the inherited IRA, or
You do not take the required minimum distribution for a year as a beneficiary of the IRA.
You will only be considered to have chosen to treat the IRA as your own if:
You are the sole beneficiary of the IRA, and
You have an unlimited right to withdraw amounts from it.
However, if you receive a distribution from your deceased spouse’s IRA, you can roll that distribution over into your own IRA within the 60-day time limit, as long as the distribution is not a required distribution, even if you are not the sole beneficiary of your deceased spouse’s IRA.
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Inherited from someone other than spouse
If you inherit a traditional IRA from anyone other than your deceased spouse, you cannot:
Treat the inherited IRA as your own
Make any contributions to the IRA
Roll over any amounts into or out of the inherited IRA.
However, you can make a trustee-to-trustee transfer as long as the IRA into which amounts are being moved is set up and maintained in the name of the deceased IRA owner for the benefit of you as beneficiary.
Like the original owner, you generally will not owe tax on the assets in the IRA until you receive distributions from it. You must begin receiving distributions from the IRA under the rules for distributions that apply to beneficiaries.
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.
For non-spouse beneficiaries, the “stretch” option is important to consider. The stretch gives you the ability to shelter funds from taxation while they grow. In the case of a Roth IRA, earnings accumulate tax-free.
If you declare bankruptcy, the assets are no longer protected. In 2014, the U.S. Supreme Court ruled that inherited IRAs aren’t protected by federal law from creditors if you declare bankruptcy. Some states, including Alaska, Florida, Missouri, North Carolina, Ohio, and Texas, do offer some protection for these assets during bankruptcy. So if bankruptcy is a possibility for you, you should consult your state’s tax laws regarding this issue within bankruptcy.
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The IRS has a lot of important information about IRAs and beneficiaries on its website.