An inherited IRA is the term used to refer to an Individual Retirement Account that you inherit after a death. Generally, an IRA will pass outside of probate to a designated beneficiary. What happens next is going to depend upon what the beneficiary decides to do. An IRA is a special kind of investment account because there are tax breaks given when either investing or withdrawing in an IRA. As a result, you cannot just treat the inheritance of an IRA like you would a bank account or standard brokerage account you inherit. You need to know the inherited IRA rules so you do not end up getting a big tax bill or facing substantial financial loss.
Sinclair Prosser Gasior understands the rules for an inherited IRA and can provide you with guidance on what your best course of action is once you have inherited. Give us a call to speak with a Maryland retirement planning lawyer to learn more about why an IRA is treated differently when you inherit and to find out what to do if you were the beneficiary on someone’s IRA.
Why is an Inherited IRA Treated Differently Than Other Investment Accounts?
An IRA is an account that a person is allowed to invest in primarily for purposes of providing retirement savings. There are different kinds of IRAs including traditional, SIMPLE, SEP, and Roth IRAs. Each of the different kinds of IRAs provides tax breaks to those who put money into them. For example, a traditional IRA lets most people put away $5,500 (as of 2016) in pre-tax funds into their accounts. This can provide a significant tax savings and essentially means the government is subsidizing the IRA.
To make certain that you cannot just use this subsidized money for other purposes besides retirement, and to make sure you cannot just hoard millions in an IRA to pass down a tax-free inheritance, there are rules for when and how money can be withdrawn from an IRA. There are also special rules for an inherited IRA.
What are the Rules for an Inherited IRA?
The rules for an inherited IRA are going to vary depending upon what your relationship is to the person who owned the IRA who died and left it to you.
If the IRA was a traditional one and a spouse inherits it, there are a few different options available. One option is a spousal transfer, which essentially involves treating the IRA just as if it were your own IRA. Just like with your own IRA, you can start taking money out at any time but a tax penalty will apply if you withdraw any of the money before aged 59 ½. You are subject to all the same distribution rules as if the money was in your own IRA to begin with.
If you are a spouse and inherit a traditional IRA, you could also open an inherited IRA in your name, transfer assets into it, and begin using the life expectancy method to take distributions. Distributions would have to begin no later than December 31 of the year when the original accountholder died . The annual distributions would be spread over a single life expectancy, determined by your age in the calendar year of your deceased spouse’s death and re-evaluated annually.
A third choice for a spouse who inherits an IRA is to open an inherited IRA that is held in your name and use the five-year method. You would transfer the IRA assets into the IRA and the money must be fully distributed within five years from the time of death of the accountholder. These is no early withdrawal penalty (like there would be if you transferred the money into your own IRA and tried to take it out before reaching 59 ½). You are going to be taxed on each distribution, just as you would if you were taking money out of any other IRA.
Finally, the last choice under the inherited IRA rules for a spouse is to take a lump sum distribution of the money in the IRA. You pay income taxes on the money, but you don’t incur an early withdrawal penalty.
Getting Help from A Maryland Retirement Planning Lawyer
These are the inherited IRA rules for a person who inherits a traditional IRA from a spouse. There are different rules if you inherit a Roth IRA or if you inherit from anyone other than your husband or wife. The rules are confusing and the choice you make can have a big financial impact, so contact Sinclair Prosser Gasior today to get help if you have an inherited IRA. Give us a call at 410-573-4818 or contact us online to speak with a Maryland retirement planning lawyer and find out about the assistance we can offer.