What we’ll cover:
You probably already have a basic idea of what an IRA is and how these individual retirement accounts work. But not many people have heard of an “Inherited IRA.” Curious? Read on.
An Inherited IRA is a type of account you can open when you inherit an IRA or an employee-sponsored retirement plan (e.g., 401(k) plan). It is specifically for receiving and holding any funds you transfer from a retirement account that you’ve inherited.
Inherited IRAs are also sometimes called “Beneficiary IRAs” or “beneficiary distribution accounts.” They’re usually a common option for individuals who have inherited a retirement account from someone other than their spouse.
Unlike a Traditional or Roth IRA, you can’t make any new contributions (translation: you cannot add personal funds) to an Inherited IRA. This type of account can only hold the funds you’ve inherited.
But they do provide a few benefits.
For example, if you’ve inherited a retirement account from a family member (who’s not your spouse), transferring the inherited funds into an Inherited IRA allows the money to continue to grow tax-deferred. And it gives you the option of spreading your distributions over a certain number of years – instead of taking a lump-sum distribution immediately.
You can open an Inherited IRA through an IRA custodian, which is simply a financial institution that’s an IRA provider and is able to hold the inherited funds, maintaining the account for you.
Banks and brokerage firms are just some examples of institutions that can serve as IRA custodians. By law, IRA custodians are required to follow all regulations governing these retirement accounts. It’s a good idea to go over the rules and other account details (e.g., fees) with your custodian and ask any questions you may have regarding your specific situation.
The IRS has certain rules when it comes to distributing funds from your Inherited IRA – for instance, when funds must be distributed from the account. The distribution requirements depend, in part, on your relationship to the person who named you as beneficiary of their retirement account. Spouses and non-spouses (i.e. friend or family member) have different distribution rules they must follow.
Figuring out your distribution obligations can get head-spinningly complicated, especially in light of a new law (the SECURE Act) that Congress passed in December 2019, bringing major changes to the rules governing inherited accounts starting in 2020.
So don’t be shy about asking for help from a financial advisor to understand how these rules may apply to you and the tax implications of your distribution options.
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