Options When an Inherited IRA CD Matures

It is important to understand the rules regarding an inherited IRA CD.

It is important to understand the rules regarding an inherited IRA CD.

As a beneficiary of an individual retirement account, your choices for handling the inheritance depend on your relationship to the deceased, the other beneficiaries and your age. A spouse has the most options regarding when to remove assets from an inherited IRA. The timing of withdrawals from a traditional IRA determines when you’ll face the tax bill.

Certificates of Deposit

A certificate of deposit is an interest-bearing security for savers. Changes to prevailing interest rates do not change a CD’s principal amount or interest payments, though they will influence the rates available if you choose to renew the CD when it matures. CD interest can compound continuously, daily, monthly or on some other schedule. Whenever the interest compounds, the bank or other issuer adds it to the CD’s principal so that you begin earning interest on interest. Normally, CDs offered by banks are insured by the Federal Deposit Insurance Corporation and can mature in months or years. You forfeit some interest if you redeem a CD before it matures.

Spouse’s Options

A spouse can assume ownership of an inherited IRA or roll it over into her own IRA. In either case, the rules for required minimum distributions from the inherited IRA are identical to that of a spouse’s existing IRA. She must begin distributing the assets from a traditional IRA starting at age 70 1/2, but need not ever withdraw assets from a Roth IRA. The spouse can use the proceeds from a maturing CD to renew it, use the money elsewhere in the IRA or withdraw the money. If the IRA is a traditional one, any withdrawals increase the spouse’s taxable income, but Roth withdrawals are tax-free.

Other Beneficiaries

Non-spouse beneficiaries can choose to postpone withdrawals from an inherited IRA until the end of the fifth year following the year of the IRA owner’s death. They may instead choose to take annual distributions based on the life expectancy of the oldest beneficiary, as determined on Sept. 30 of the year following the IRA owner’s death. This means that the age of any beneficiary who receives or renounces the inheritance before this date is not used to determine the oldest beneficiary. If any of the beneficiaries is not an individual, the distribution schedule depends on whether the deceased had reached before death the required beginning date for minimum distributions. If so, then distributions are based on the deceased’s age. Otherwise, the five-year rule applies.

Considerations

A beneficiary’s tolerance for risk and demand for return might determine how she reinvests the maturing CD’s proceeds. CDs are safe but might pay puny interest. Non-spouse beneficiaries can't roll an inherited IRA over to other IRAs except for ones that the deceased had set up for the benefit of the beneficiary. This means that if the custodian of the inherited IRA is a bank, non-spouse beneficiaries might not have the option of investing the CD proceeds in securities not offered by the bank, such as stocks, bonds and mutual funds. In this case, a beneficiary’s choices are limited to the bank’s products unless she withdraws the proceeds and forks over any tax due.

 

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