By Majda Muhic, Spring 2017 Student Intern
Many investors open an Individual Retirement Account, or IRA, with an eye to their own bright future and the promise of a comfortable retirement. Rarely, if ever, does an investor opening an IRA consider the possibility or the complex financial implications of her own death. Yet, a generation of investors is emerging that has or will at some point inherit someone else’s IRA. Addressing some of the key issues surrounding this complex yet often overlooked topic, FINRA issued an Investor Alert on January 2 this year entitled Inherited IRAs – What You Need to Know.
FINRA’s Investor Alert outlines the issues. When opening an IRA, an investor typically names a beneficiary. Regardless of the investor’s will or trust, this named beneficiary inherits the IRA assets upon the investor’s death. The transition from a decedent’s IRA to a beneficiary is generally a straightforward process facilitated by the brokerage firm holding the account. Several questions, however, often arise when an IRA is inherited, including when and how to withdraw money from the account and when a distribution is required. While age and account type affect minimum distribution rules, the most important factor appears to be whether the IRA is inherited by a surviving spouse.
Surviving Spouse Beneficiary
Most often, the IRA beneficiary is a surviving spouse. If you are a surviving spouse and inherit an IRA, you can name yourself as the account holder and so effectively create a new IRA in your name. Any required minimum distributions in this case are determined as if you were the account owner. You can also roll the inherited IRA into an IRA you already hold or into your 401(k) or 403(b). The assets, and any required distributions, are again treated as your own.
Alternatively, you can choose to remain a beneficiary and take distributions over a five year period, or over your own or the original owner’s life expectancy. You can also decide to take a lump-sum distribution, for which you may incur taxes but no early withdrawal penalty regardless of your age. Finally, you can also renounce the inherited IRA and simply choose not to take ownership of it at all.
Non-Spouse and Multiple Beneficiaries
If you are a non-spouse beneficiary, your options are far more limited. You may not treat the inherited IRA as your own, and can therefore not make any contributions to it. Like a spouse beneficiary, you can take a lump-sum distribution or decide not to take ownership of the inheritance at all.
Sometimes, an investor designates multiple beneficiaries to an IRA. In this case, it is often advisable that each beneficiary establish a separate account. In any case, it is key that you consult a tax or financial professional to assess any tax implications of an inherited IRA as well as a legal professional to ensure that all legal requirements are met.
In its Investor Alert, FINRA provides a few tips for designated IRA beneficiaries, including notifying the brokerage firm of the IRA account holder’s death as soon as possible and providing all required documentation. Three additional tips are particularly relevant for surviving spouse beneficiaries: first, take time to understand your newly acquired investment holdings, including their risks and restrictions; second, carefully investigate your options before deciding to sell any of your newly acquired assets; and third, consider moving the inherited account from its original brokerage firm or broker – they may not be right for you and you should conduct due diligence on them just as you would if you were opening a new account.
For more information on inherited IRAs, visit the full FINRA investor alert.