The rules on IRAs can be complicated whether they are for a Traditional IRA or Roth IRA. However, the rules on inherited IRAs can even be more complicated.
For example, an owner of one’s own Traditional IRA must begin to take distributions by April 1st after the year they turn age 70 ½. This Required Minimum Distribution rule (RMD) does not apply to Roth IRAs. If you inherit an IRA, and you are not the surviving spouse, you must start to make withdrawals (RMDs) by December 31st in the year after the IRA owner died. Furthermore, this rule applies whether the inherited IRA is a Traditional or a Roth IRA. There is no age requirements or exceptions.
Failure to take the required minimum distributions results in a drastic 50% penalty for the amount of distribution that should have been made. You also need to be aware that any distributions received before you are age 59 ½ may be considered as taxable ordinary income and also be subject to a 10% excise penalty.
The distributions are based on your age and life expectancy and are determined in the Single Life Expectancy Table that is found in IRS Publication 590 (Individual Retirement Arrangements). You should make sure that you follow the instructions carefully to make sure you are taking the correct distribution for the initial and subsequent years. IRA distributions received over this time period are also known as “stretch IRAs”
You also need to make sure that you set up a separate IRA beneficiary account, as you are not allowed to combine or commingle assets with IRA accounts in which you are the original owner. You are also not allowed to make any contributions to the inherited IRA.
You should also be aware of the option to take your distributions within five years of the owner’s death. This option is only available if the owner of the IRA died before the age of 70 ½. If the owner died after the age of 70 ½ and was taking their own RMDs, then you have the option of using your age or the age of the decedent. If the decedent was younger than yourself, you will have the benefit of taking the distributions over the longer time period.
Other things you need to be aware of are making sure that any transfer of IRA assets be made directly from one financial institution to another. If the trustee-to- trustee direction is not made and you receive the check directly, you have until 60 days to transfer into the other account. Failure to do so may result in that amount being reported to the IRS as taxable income.
You also need to consider if there are multiple beneficiaries in addition to yourself, as you need to make sure that the IRA is properly split among the different beneficiaries. If the IRA account is not properly divided, then the age of the oldest beneficiary will be used which will result in a shorter distribution period.
In conclusion, it is important that you update your beneficiary designations for your own IRA accounts as certain life milestones may happen (marriage, children, and divorce. You should also inquire with your family members or other persons to see if you are named as a beneficiary on their IRA accounts. This is important as you need to be aware of the complex rules of inherited IRAs.