Inheriting an IRA

Volume A2, Issue 2007

At the ripe old age of 32, individual retirement accounts (IRAs) are proving quite popular. According to recent research, individuals had $3 trillion in IRA investments at the end of 2003.* That's a significant amount — and some of it is likely to pass from the IRA owners to their beneficiaries. If you inherit a traditional IRA, the choices you make will determine your distribution options and the resulting tax consequences.

Surviving Spouses

If you are the sole designated beneficiary of your spouse's IRA, you have three basic choices. One is to simply leave the account as it is. You will be able to withdraw funds without penalty, although income tax will be due on the distributions (except for amounts that represent a return of nondeductible contributions). Annual distributions of a minimum amount will be required. They can be delayed until your spouse would have reached age 70½, if desired.

Your other choices are to either roll over the IRA into a new IRA in your own name, or elect to treat the IRA as your own. In either case, you can name your own beneficiaries, and you won't be required to take minimum distributions (and pay the resulting income taxes) until after you reach age 70½. However, if you make withdrawals before age 59½, they may be subject to a 10% early withdrawal penalty.

Nonspouse Beneficiaries

If you inherit an IRA from someone other than your spouse, the choices and tax consequences are a little different. You can leave the IRA in the deceased owner's name, but you can't postpone distributions. You generally must begin taking annual minimum distributions, spread over your life expectancy, right away. (In certain circumstances, the entire account must be distributed within five years.) And, of course, income taxes will be due on the distributions.

Beginning in 2007, you may also choose to roll over the IRA into an IRA in your own name. Unlike spouse-beneficiaries who may postpone distributions, however, you will generally have to begin taking distributions (and paying income tax on them) immediately.

* "The Individual Retirement Account at Age 30: A Retrospective," Investment Company Institute Perspective (February 2005), Investment Company Institute®.