Inherited IRA rules

Jan 092012

When inheriting IRA accounts there are several inherited IRA rules you should take into account before taking any action. If you don’t you might do costly mistakes that can’t be reversed. This list is not exhaustive, but should get you started. For further reading, read our main article about inherited IRAs or any of the related articles in the side bar.

Inherited IRA Rules – rule #1

This is the most important one. You are not allowed to transfer money between inherited IRAs like you are when you are doing a normal IRA rollover between your own accounts. With a normal rollover, you get a check from the custodian over the rollover amount and you have 60 days to roll that money into another account. This is often used to borrow money from an IRA. If you have an inherited IRA though, you are only allowed to make trustee-to-trustee transfers. That means, at no point during the transfer should there be a check issued to your name over any money from the inherited IRA. If that happens, the money is interpreted as direct cash out and will be subject to income tax.

Inherited IRA Rules – rule #2

If you inherited a 401(k) the employer may allow you to stretch out the withdrawals. If the late person was not your spouse, the employer will generally want you to transfer the assets to an inherited IRA account under your control.

Inherited IRA Rules – rule #3

If there is no beneficiary form on file, the custodian default benefactor rules will apply. These vary between custodians. In most cases the first benefactor will be the spouse, if that does not apply or the spouse disclaims the inherited IRA the assets will be awarded to the estate. In many other cases the estate will be awarded directly without regard for the spouse. Very few custodians will award the assets directly to the kids.

Inherited IRA Rules - rule #4

If you are not the spouse or if you are the spouse but the circumstances require you to start taking the required minimum distribution, you have until the end of the next year after the original IRA owner’s death to take the minimum required distribution. If you don’t, you will face a 50% penalty of the amount you were supposed to take.

Inherited IRA Rules – rule #5

If there are multiple beneficiaries you should ask to have multiple inherited IRA accounts to be created, one for each beneficiary. This way you avoid disputes over how the money should be managed and invested in the future.

Inherited IRA Rules – rule #6

Don’t take anything you read on the internet for granted. As this is only general information and – as noted in the footer – shouldn’t be construed as either tax or legal advice, you should talk to an attorney and/or tax professional before you take any action.

Conclusion

There are many more inherited IRA rules and circumstances that govern the proper handling of inherited IRAs and IRA accounts in general. Feel free to read our other articles on this site to get a better understanding of the big picture.