If you are a nonspouse relative or even a close friend of an IRA owner who has named you as his or her beneficiary, it’s critical that you and the owner of the IRA understand the specific rules that govern IRA inheritances.
IRA owners are required by the IRS to start taking minimum required distributions (MRDs) no later than April 1st following the year in which they turn 70½. These rules also apply to whoever inherits an IRA. In addition, distributions taken prior to age 59½ (either by the IRA owner or the inheritor) could be subject to a 10% early withdrawal penalty, depending on the type of IRA.
When you transfer assets from a traditional IRA into an IRA beneficiary distribution account (inherited IRA), the rules for MRDs still apply. This means you must withdraw a certain amount of money from your inherited IRA each year, based on your age and life expectancy. In the case of a non-spouse inheritor, though, MRDs will need to begin before the inheritor reaches age 70½. However, if the original IRA was a Roth IRA and the assets were in the account for five years or more, prior to the death of the original owner, distributions may be tax free. Consult a tax adviser if you feel you’ve inherited a Roth IRA that wasn’t opened for five years before the original owner died.
Typically, you have until December 31st of the year following the original IRA owner’s death to take your first MRD. Each year thereafter you will be required to take an MRD until the account is depleted or you pass away, at which time the assets will pass to your beneficiaries. The beneficiary’s MRDs will be calculated using your age in the year following your death and based on the Single Life Expectancy table.
If the original IRA owner died before reaching age 70½ (before MRDs would be required of the original owner), you also have the option of distributing your inherited IRA under the five-year rule. This allows you to take distributions however you like without penalty, so long as all assets are completely distributed from your inherited IRA by December 31st of the fifth year following the IRA owner’s death. Your tax adviser can discuss with you the potential tax implications of this accelerated withdrawal schedule
However, if the original IRA owner died after reaching age 70½, then you must continue to take annual MRDs from your inherited IRA. You may elect to calculate those MRDs by using your own age (see the discussion above) or by using the deceased IRA owner’s age in his or her year of death. This option may be advantageous if the deceased IRA owner was younger than you.
ALWAYS CONSULT YOUR TAX ADVISOR.