An Inherited IRA is an account established by the beneficiary of an IRA who would like to retain the tax advantages of the assets held in that account.
An Inherited IRA can be entirely distributed within five years of its inception, or distributed over the beneficiary's lifetime.
An Inherited IRA maintains the tax advantages of the original account: Traditional or Roth.
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Foundations of Self-Directed IRAs
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How does an IRA account holder assign an IRA to a beneficiary?
The IRA account holder will assign their assets to a beneficiary through the completion of a beneficiary designation form. The account holder will fill out these forms either at the opening of the account, or submit these forms later as an amendment to the account.
What types of beneficiaries are there?
- Primary Beneficiary:The individual, trust, charity, or any combination of the three that will inherit the IRA when the IRA account holder dies.
- Contingent Beneficiary: The person who will inherit the IRA account if the primary beneficiary dies.
In Community Property States (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), if the spouse is NOT the primary beneficiary, she or he must sign permitting someone else to be the Primary Beneficiary.
A benefactor can name his or her spouse, children, grandchildren, or any other individuals. Benefactors may also name a trust, charity, or some combination of the above. See IRS Publication 590 for additional rules governing each type of beneficiary.
Who can be named a designated beneficiary of an IRA?
Why should I name beneficiaries?
Naming a beneficiary provides the IRA account holder the estate planning knowledge of who will inherit their IRA at their death. Additionally, it can be a tax advantage for your heirs, inasmuch as it bypasses probate.
Will my will or trust override who I list as my designated beneficiary?
The beneficiary designation generally overrides a will or trust.
How often should I review my beneficiary designations?
Life events such as marriage, the birth of a child, starting your own business, a divorce, or a death are all reasons to review your beneficiary designation and see if your objective has changed. It is a good idea to review your beneficiaries periodically, and share that information with anyone assisting you in your estate planning goals.
What if the deceased IRA holder is a NON-spouse?
- Non-spouse beneficiaries may:
- Open an Inherited IRA, transfer the assets to that IRA, and take required minimum distributions.
- Distribute IRA assets immediately and pay the taxes.
- Open an Inherited IRA and distribute IRA assets over a 5-year period, thereby spreading out the tax liability.
- The beneficiary has one year to decide which action to take, and to execute the action.
What is the process for opening an Inherited IRA?
The process of opening an Inherited IRA is the same as opening a normal IRA account, but the beneficiary will need to provide a copy of the benefactor’s death certificate and a beneficiary election form.
Inherited IRAs follow a special titling convention to indicate both the beneficiary and the original IRA holder:
New Direction IRA, Inc. FBO [beneficiary] bene [decedent] dcdt., BENE IRA
Example: New Direction IRA, Inc. FBO John Doe bene Joanne Doe dcdt., BENE IRA (Joanne was John’s mother).
Things to keep in mind regarding Inherited IRAs:
- Typically, you are able to withdraw money from your IRA without penalty as long as you return it the account in full within 60 days. When an IRA is inherited, that luxury does not apply.
- The funds you inherit must be moved from one IRA custodian to another, or a trustee-to-trustee transfer. You must also retitle the name of the Inherited IRA – see details about titling Inherited IRAs below.
- IRAs can be split between multiple beneficiaries. Spouses have the option to roll the assets into their own IRA and wait to distribute the money from a traditional IRA until he or she reaches the age of 70 ½.
- Heirs who are not spouses must begin taking minimum distributions the year the account holder died—regardless of whether the account is a Roth or Traditional; that is, post or pre-tax.
- You can lower your distribution requirements by dividing the total amount in the IRA passed down by your life-expectancy, instead of using the typical IRA distribution guidelines. This will elongate the tax benefits of the account.
- Some 401(k) accounts are different, particularly if they are employer plans. Employers may not let beneficiaries stretch out the benefits of a plan.
- At the end of your life you can plan to stretch out the benefits of your holdings by naming younger beneficiaries, like your kids, as primary beneficiaries and your grandkids as alternates.
- By leaving the money to an estate, you force the heirs of the estate to distribute that money within 5 years.