IRA Beneficiary Rules

By Nathania Maddox

  • Overview

    Inheriting a traditional individual retirement account (IRA) can yield a nice-sized sum of money, as well as considerable potential headaches for the beneficiary. Thanks to the dense and complex Internal Revenue Service rules that govern taxation of such savings plans, recipients of a deceased owner's IRA have to evaluate numerous issues to make the best decision about how to handle the funds and avoid related tax penalties.
  • Types

    There are generally two types of recipients that IRA owners can name as beneficiaries of their account upon their death: a spouse and a non-spouse. The latter category includes human beneficiaries, such as other relatives, and organizations, such as a charity. In addition, there are two kinds of IRA that a beneficiary can inherit: one in which the owner had already started receiving regular distributions before death and one in which the owner had not yet reached the required age of 70 1/2 years before mandatory annual distributions begin. If distributions had already started and the spouse who inherits and keeps the IRA is already older than 70 1/2, he must begin receiving distributions by December 31 of the year of the original owner's death. If he is younger than the mandatory distribution age, however, he has to begin withdrawals by April 1 of the year he turns 70 1/2.
  • Features

    A spouse who inherits a traditional IRA can roll the account over into another IRA account she owns, either existing or new; have the account converted to a beneficiary distribution account under her name and the original deceased owner's name to avoid the 10 percent IRS penalty for early withdrawals; give the account away to another beneficiary of her choice if she doesn't need the funds; or cash out the account and become subject to substantial potential tax penalties. A non-spouse beneficiary has the same options except for rolling over the account.
  • Time Frame

    When a beneficiary of a traditional IRA decides to keep the inheritance or give it to another newly designated beneficiary, the tax-free withdrawal requirements are identical to those for the original owner. The account will continue growing and tax penalties won't apply as long as there are no withdrawals before the age of 70 1/2 years. If there are withdrawals before that point or the beneficiary opts to cash out the account, then penalties will apply immediately and the amount of money taken out will be considered taxable income for the year of withdrawal.
  • Considerations

    Just as there are various types of IRAs, there are different rules that apply to each kind and that impact what happens when withdrawals begin. Moreover, applicable IRS rules can and do change. Beneficiaries should consult an accountant, lawyer, or tax professional upon learning of an IRA inheritance to ensure the rules are followed.
  • Warning

    When IRAs become part of an estate before they pass to beneficiaries, the inheritance is often much smaller due to the different tax rules that apply. To avoid this problem, IRA owners should make sure to name the desired beneficiaries on the appropriate IRA forms before death.
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