Inherited IRA Vs. Beneficiary IRA

Beneficiaries need to make a decision on how to receive an IRA account.

Beneficiaries need to make a decision on how to receive an IRA account.

If your spouse passes away leaving you as the named beneficiary of his IRA, how you'll handle that money might not be your immediate concern. Fortunately, the Internal Revenue Service gives you one calendar year following the year in which your spouse died to determine whether you want to treat the account as an inherited IRA -- meaning you make it your own -- a beneficiary IRA or choose another option available to non-spouse beneficiaries. However, not making a decision within the required time could have serious financial ramifications.

Inherited IRA Treatment

As a spouse beneficiary, you have options not available to non-spouse beneficiaries. One of those options is to take over your spouse's IRA. By doing this, you can roll it over into a new account in your name, or you can combine it with your own IRA if you have one. If you're rolling a traditional IRA into another traditional IRA, you won't have to pay any taxes until you start receiving distributions, you can continue to contribute to the plan and you won't have to take distributions until you are age 70 1/2. If you roll an inherited Roth IRA into your own Roth, the same applies, but you never have to take out the money, and distributions will be tax-free if the plan was in effect for five years. If you roll an inherited traditional IRA into a Roth, you will pay taxes on the entire amount. The drawback to treating the IRA as an inherited IRA is that if you need the money before you are age 59 1/2, you'll be subject to the 10 percent early withdrawal penalty on top of any taxes you owe.

Beneficiary IRA

As a spouse, you can also treat your deceased spouse's IRA as a beneficiary IRA. In this case, the IRA would be treated as though it were still your spouse's IRA. So you could take distributions without a penalty when your spouse would have reached age 59 1/2. This can be a benefit if your spouse was much older than you, because you can still receive tax-deferred investment income -- tax-free for a Roth -- but you wouldn't have to wait so long to take distributions. The drawback is that a penalty still applies to early distributions, and if it's a traditional IRA, you would have to take required minimum distributions when your spouse would have reached age 70 1/2.

Non-Spouse Beneficiary Options

As a spouse, you also have the options available to a non-spouse beneficiary. These are to withdraw the entire amount from the account within five years beginning with the first calendar year following the year in which the IRA owner died or begin taking required minimum distributions based on your life expectancy within that same period. As with any distributions from a traditional IRA, they would be taxed as ordinary income. Roth distributions would be tax-free if the plan had been in effect for five years.

Important Considerations

If your spouse were old enough when he died to have begun receiving required minimum distributions, it's important that you take the distribution he should have taken by the time it would be due. Otherwise, you face a penalty of 50 percent of the required distribution. If you don't take some other action within the required time -- that is, treating the IRA as an inherited IRA, making it a beneficiary IRA or beginning required distributions within the first year following the year of death -- then you will have to take a full distribution within five years along with any tax consequences.


About the Author

Nancy Cross is a certified paralegal who has worked as an employee benefits specialist and counseled employees on retirement preparation, including financial and estate planning. In addition to writing and editing, she runs a small business with her husband and is a certified personal trainer with the Aerobics and Fitness Association of America (AFAA).

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