Options for Non-Spouse Beneficiaries of Inherited IRAs
From: www.thebalance.com
Cashing Out Your Inherited IRA vs. Stretching Out Your Inherited IRA
You have several options for what you can do with an inherited IRA if you aren’t the spouse of the account owner. Unfortunately, many IRA beneficiaries aren’t aware of all their options, so they immediately cash out the IRA and end up with a huge income tax bill.
But income taxes can be minimized by simply choosing the option that results in the smallest tax hit. You might have up to four choices. You won’t be allowed to roll over the inherited IRA into your own IRA, but you can take distributions from the inherited IRA without paying the 10 percent penalty for early withdrawals.
Option No. 1: Cash Out the IRA in 5 Years
A non-spouse IRA beneficiary can withdraw all the funds from the IRA by Dec. 31 of the fifth year following the IRA account owner’s death. Each withdrawal will be included in your taxable income during the year the funds are withdrawn. You don’t have to take the distributions in installments, but you must withdraw all the funds prior to the applicable Dec. 31 date.
This can be an option if the account owner had not yet reached age 70 1/2 at the time of her death and was not yet taking required minimum distributions (RMDs).
Option No. 2: Take RMDs Over Your Own Life Expectancy
You might be able to take RMDs over your own life expectancy, leaving the bulk of the account to continue to grow tax-deferred. This is often referred to as a “Stretch IRA.”
You’ll potentially be able to create a nice little nest egg for yourself if you’re significantly younger than the IRA account owner was and you choose this option. You’ll also be able to take out more than your required minimum distribution in any given year if you find you need to do so.
As with option No. 1, each distribution taken will be included in your taxable income during the year the funds are withdrawn. You must establish a separate inherited IRA account in the deceased account owner’s name for your benefit if you choose this option, and you must take your first RMD by Dec. 31 of the year following the year of the account owner’s death.
The inherited IRA account would be titled “John Doe, IRA (deceased 1/1/18), FBO Sally Doe, beneficiary.” You should be also able to name your own primary and secondary beneficiaries if you die and funds still remain in your inherited IRA at the time of your death.
If the original owner was over the age of 70 1/2 and was taking RMDs, you also have the option of continuing to take her RMDs.
