While a beneficiary Individual Retirement Account (IRA) has the same fundamental tax advantages of a traditional IRA, there are very different rules regarding the handling of beneficiary accounts. Specifically, distributions may be required from beneficiary accounts before they generally would be taken from a traditional IRA, and certain Internal Revenue Service (IRS) penalties may be waived. In addition, beneficiary rules are different depending on whether a spouse or non-spouse inherits the IRA.
Traditional IRA and How it Works
A traditional IRA is a retirements savings account that allows for tax-deferred growth of contributions and earnings. Contributions are tax-deductible, within annually-updated IRS limits, and withdrawals are generally taxable at ordinary income rates.
Required minimum distributions (RMDs) must be taken when the account holder reaches the age of 72, and withdrawals generally cannot be taken before the age of 59 1/2 without incurring a 10 percent IRS penalty. Beneficiaries must be designated by account holders.
Beneficiary IRA and How it Works
A beneficiary IRA is an IRA account that has passed from the decedent to an heir. While some IRAs pass to a single beneficiary, others are split amongst multiple beneficiaries. In the case of multiple beneficiaries, assets are split according to the percentage division specified by the decedent. One of the jobs of an estate executor or administrator is to locate the beneficiaries of an IRA and make the appropriate distribution.
Read More: IRA & Beneficiary Rules of Succession
Spousal IRA Inheritance
A spousal IRA is a beneficiary IRA that is passed to the spouse of the decedent. A spouse who is an IRA beneficiary has the option of treating the account as his own, by retitling the account in his own name. As such, the spouse beneficiary is allowed to make contributions, take distributions, rollover assets and otherwise treat the account as if he had always owned it.
A non-spousal beneficiary does not have the option to treat an inherited IRA account as his own. No contributions can be made to this type of inherited IRA, and the account cannot be rolled over into other IRA. In addition, distributions from these IRAs must begin immediately.
The amount of the required minimum distribution depends on whether the decedent had already begun taking his own RMDs. If so, then the beneficiary can either continue taking distributions based on the life expectancy of the original account owner, or he can consult IRS Table I to determine distributions based on his own life expectancy. If the owner had not yet begun taking RMDs, then the beneficiary can take distributions based on his life expectancy only.
Taxation and Penalties
All distributions from beneficiary IRAs are taxable at ordinary income. For a spouse choosing to treat the inherited IRA as his own, mandatory distributions are not required until he reaches age 72. However, withdrawals taken before the age of 59 1/2 are subject to a 10 percent IRS penalty, a penalty which is waived for non-spousal beneficiaries.
Read More: Taxes for Traditional IRA Withdrawals
John Csiszar earned a Certified Financial Planner designation and served for 18 years as an investment counselor before becoming a writing and editing contractor for various private clients. In addition to writing thousands of articles for various online publications, he has published five educational books for young adults.