Five things to know about inheriting an IRA

I received a lot of emails after my recent article on required minimum distributions (RMDs), the IRS-mandated withdrawals you normally must make from a traditional IRA once you turn 70½. While that kind of feedback isn’t unusual, it was a surprise that so many asked about the rules for someone who inherits an IRA. 

This can certainly be a financial boost, but it also presents opportunities for costly missteps. Given these, your first step should be to talk with a tax professional or your financial adviser to review your options. 

Although not an exhaustive list, here are five things you should understand if you inherit an IRA.

• Both Roth and traditional IRA beneficiaries are subject to RMD rules. A Roth IRA account owner doesn’t have to take RMDs; however, if you’re a beneficiary of a Roth IRA, you do.  
• “Stretching” can extend tax benefits. The IRS allows a beneficiary to set up an inherited IRA and take distributions based on life expectancy. If you want to take advantage of this option, the first distribution must be made by Dec. 31 of the year following the owner’s death. It doesn’t limit how much you could take out; the beneficiary could later decide to withdraw 100 percent. This option provides the most flexibility for non-spouse beneficiaries.
• Be aware of the five-year rule. If you miss the deadline noted above and the original owner was younger than 70½, you’ll default to the five-year rule. Under this scenario, you’re not required to take distributions each year, but you must withdraw the entire account by Dec. 31 of the year in which the fifth anniversary of the account owner’s death occurs. 
• A spouse has more options. A spouse beneficiary can take the proceeds as his or her own IRA or set up an inherited IRA. If they treat it as their own, the proceeds would be subject to the normal RMD rules. With an inherited IRA, you would need to begin life expectancy distributions Dec. 31 of the year after your spouse’s death or Dec. 31 of the year when your spouse would have turned 70½, whichever comes later. 
• The rules for moving an inherited IRA are different. Unlike an owner who can normally withdraw money and move it to a new IRA within a 60-day period as a rollover, inherited IRAs can only be transferred directly from one custodian to another. 

These scenarios should help you consider the options if inheriting an IRA, but before pursuing any of them, talk with a financial or tax professional to map out the plan that best fits your situation.

J.J. Montanaro is a certified financial planner with USAA, The American Legion’s preferred provider of financial services. Submit questions for him online.