By: Megan Makuck, Investor Advocacy Clinic Intern Fall 2017
The circumstances that create a need for Inherited IRAs are never ideal. However, as they inevitably come about, and because Inherited IRAs can be complex, it is important to have a general understanding of how they work and what your options are as a beneficiary to one.
Upon setting up a Traditional or a Roth IRA, the account holder designates one or more beneficiaries. When the IRA account holder passes away, the beneficiary inherits the IRA. Brokerage firms have a process in place for handling this, which typically starts with filling out a beneficiary claim form. Before the beneficiary makes any other decisions regarding the newly inherited IRA, he or she will want to read up on how Inherited IRAs operate. Brokerage firms can provide this information. Keep an eye out for the distribution rules and the consequences of withdrawing funds from an IRA. The IRS is a great source to learn about tax-related information, as it can get complicated.
As a beneficiary, the options available for inheriting an IRA depend heavily on whether the beneficiary is a spouse or non-spouse. When a spouse inherits the IRA, he or she has five options.
- The spouse can treat the inherited IRA as his or her own by opening a new IRA account with the beneficiary as the account holder.
- The spouse can roll the inherited IRA into his or her own current traditional IRA account or qualified employer plan.
- The spouse can keep the IRA as it is and remain as the beneficiary to the inherited IRA. This will require changing the title of the IRA to appropriately reflect this decision.
- The spouse can take a lump-sum distribution.
- The spouse can choose to not accept ownership of the IRA at all.
A non-spouse beneficiary has similar, but fewer, options than a spouse would have when inheriting an IRA.
- The non-spouse can open an Inherited IRA account and transfer the assets into that account.
- The non-spouse can take a lump-sum distribution. This option is the same as the one available to a spouse beneficiary.
- The non-spouse can choose to not accept ownership of the IRA at all just as a spouse can choose.
Inherited IRAs introduce new rules and requirements for taking out distributions, properly titling the IRA account when transferring, and choosing which funds to keep and which funds to sell. FINRA provides an Investor Alert outlining in more detail the landscape that surrounds Inherited IRAs and answering questions you may not have even known to ask.