There are about 25 million Individual Retirement Accounts in the United States, representing more than $2.5 trillion in total assets. Given the fact that they can only be held by one individual, the odds are good that you may find yourself the recipient of an IRA account at some point. And since they are strictly governed by a special set of rules, you will want to carefully observe the rules of the road as a beneficiary of an inherited IRA. Mistakes can be costly in terms of taxes and possibly even IRS penalties if you run afoul of the rules.
Christopher HopkinsFirst, the rules are different and much simpler for spouses. If your deceased husband or wife named you as the beneficiary, you may simply assume the account as your own. In the event that you have an existing IRA, your spouse’s account can be rolled directly into your own account of the same type (Roth or traditional). If you do not have an IRA account of your own, the inherited account can be retitled and assumed as your own with all the tax-deferral characteristics intact. Simple.
It gets more complicated if you are a non-spousal beneficiary. You will not be able to simply roll the assets into your own account, because the tax code requires that the money must eventually be distributed (Uncle Sam needs the revenue).
Basically, you have three choices. First, you may simply choose to cash in your chips and pay the taxes. Assuming a traditional (tax-deferred) account, you will declare the proceeds as income on your tax return. This is generally the least favorable outcome, as your distribution will be taxed at the highest marginal tax rate to which you are subject, and may easily propel you into a higher bracket.
Assuming you do not wish to distribute the entire amount, you will establish what is called an “inherited” IRA account and roll over the proceeds. At this point the clock starts running on the other two options.