Definition
An Inherited IRA, also known as a Beneficiary IRA, refers to an account that is opened when an individual inherits an IRA or employer-sponsored retirement plan after the original owner dies. The tax rules are different depending on whether the beneficiary is a spouse or a non-spouse. Contingent on several factors, the inherited funds might be required to be distributed to the beneficiary within a certain timeframe.
Phonetic
The phonetics of the keyword “Inherited IRA” can be split into two like this:Inherited: ĭn-hĕr′ĭ-tĭd.IRA: ī – ār – ā.
Key Takeaways
<ol> <li>The Inherited IRA, also known as a Beneficiary IRA, is an account that is opened when someone inherits an IRA after the death of the original owner. This account is subject to a specific set of rules set by the IRS.</li> <li>The rules for Inherited IRAs depend on the type of beneficiary. Spousal beneficiaries have different options than non-spousal beneficiaries. They can either treat the IRA as their own or consider it as an Inherited IRA.</li> <li>Inherited IRAs cannot be combined with your own IRA and the funds must generally be withdrawn within 10 years of the original account owner’s death, unless the beneficiary is a spouse, minor child, disabled or chronically ill, or not more than 10 years younger than the deceased.</li></ol>
Importance
Inherited IRA is an important term in business/finance as it refers to an Individual Retirement Account (IRA) that is passed on to a beneficiary after the death of the original owner. The significance lies in the opportunity it presents for investing and ensuring continued tax-deferred growth of the retirement savings. However, the handling of an Inherited IRA is subject to specific inheritance rules, which can significantly impact the amount inherited and the tax implications. Therefore, understanding the term is crucial in estate planning and post-death financial management for beneficiaries.
Explanation
An Inherited IRA, also known as a beneficiary IRA, serves a vital purpose in enabling individuals to pass their retirement savings to a non-spouse beneficiary, such that the legacy can continue instead of the assets being immediately liquidated upon the original account holder’s demise. This type of account is a powerful tool for wealth transference, as it displays flexibility allowing heirs to potentially stretch the inherited assets over their lifetime. An Inherited IRA is primarily used for sustaining the lifespan of these investment funds, spreading the tax burden, and protecting the inheritance. The way these IRAs are managed can impact the tax liabilities and growth potential of the inherited assets; thus, they could essentially provide an income stream for the beneficiaries. This option is beneficial for beneficiaries as it offers the opportunity to continue accumulating tax-deferred (or tax-free in the case of Roth IRAs) investment earnings. Therefore, the inherent purpose of an Inherited IRA is to extend the financial advantages of the original retirement account.
Examples
1. John’s Father’s IRA: John’s father passed away and left him a substantial amount in an IRA. This became an inherited IRA for John. He had to start taking required minimum distributions (RMDs) based on his life expectancy to avoid a significant penalty. This allowed John to stretch out the tax-deferred status of the inheritance over many years.2. Karen’s Spousal Inherited IRA: Karen’s husband had a large IRA that he had contributed to throughout his career. When he passed, Karen inherited this account and decided to treat it as her own IRA rather than an inherited one. This meant she could defer distributions until she reached the age of 70 and a half, thus prolonging the tax-deferred growth.3. Transfer of Steve’s Grandmother’s IRA to a Trust: Steve’s grandmother, upon her passing, had left her IRA to a Trust she set up before her death. The trust was named as the beneficiary of the IRA, which now became an inherited IRA. Per the law, the trust had to start taking RMDs based on the life expectancy of the oldest beneficiary of the trust. Through this, Steve’s grandmother ensured that her assets were managed as per her wishes, even after her death.
Frequently Asked Questions(FAQ)
What is an Inherited IRA?
An Inherited IRA, also known as a Beneficiary IRA, is an account that is opened when an individual inherits an IRA or employer-sponsored retirement plan after the death of the original owner.
Who can inherit an IRA?
Any individual or entity can inherit an IRA. Most commonly, individuals such as spouses, children, or grandchildren are named as beneficiaries. However, charities, trusts, or estates can also be named.
What happens when I inherit an IRA?
When you inherit an IRA, you have several options. You can either cash it out, which might result in a hefty tax bill, or choose to take minimum distributions over time. The course of action often depends on your relationship to the original owner and the type of IRA.
Can I contribute to an Inherited IRA?
No, contributions cannot be made to an Inherited IRA. It solely contains the funds inherited from the original owner’s account.
Can a spouse transfer an Inherited IRA to their own IRA?
Yes, surviving spouses have the option to transfer funds from an Inherited IRA into their own IRA, without any immediate tax consequences. This option is not available to non-spousal beneficiaries.
How is an Inherited IRA taxed?
The taxes on an Inherited IRA depend on the type of IRA (Roth or Traditional). For Inherited Roth IRAs, you usually don’t pay taxes on distributions. For Inherited Traditional IRAs, funds are taxed as ordinary income upon withdrawal.
Are there required minimum distributions (RMDs) for an Inherited IRA?
Yes, most non-spouse beneficiaries must start taking RMDs from an Inherited IRA by December 31 of the year following the death of the original owner. The amount of the RMD is determined by the IRS, and skipping these can result in a hefty penalty.
Can I name a successor beneficiary for my Inherited IRA?
Yes, beneficiaries can name a successor beneficiary for their Inherited IRA. If the original beneficiary dies, the Inherited IRA would then pass to the successor beneficiary.
What if the original owner was already taking RMDs when they passed away?
If the original owner was taking RMDs, the beneficiary needs to continue taking these distributions at least at the same pace. The exact rules depend on the relationship of the beneficiary to the original owner.
What happens if I don’t take the RMDs from an Inherited IRA?
Failing to take the RMD by the deadline results in a 50% IRS penalty on the amount that should have been withdrawn.
Related Finance Terms
- Inheritor: The person who receives or inherits the IRA from the original account holder.
- Required Minimum Distributions (RMDs): The amounts that the federal government requires one to withdraw annually from traditional IRAs and employer-sponsored retirement plans.
- Stretch IRA: A wealth transfer method that involves leaving assets in an IRA for as long as possible to maximize tax-sheltered growth.
- Beneficiary Form: A form that the original IRA owner fills out to designate who will inherit the IRA in the event of their death.
- Estate Tax: A tax on the transfer of the estate of a deceased person, which may apply if the IRA is part of the estate.
