Upstate Estate Law, P.C. Blog

Installment I of A to Z is the INHERITED IRA. Sounds pretty self explanatory doesn’t it? An inherited IRA must simply be an IRA account that you have inherited right? Well, sort’ve. An Inherited IRA is an IRA that contains either qualified retirement plan assets or IRA assets that you have inherited. The most important thing to remember is that if you are named as the beneficiary of a qualified retirement plan or IRA of a non-spouse, the use of the Inherited IRA concept can allow for continued deferral of income taxes on the assets held inside the account.

The Inherited IRA, as applied to qualified retirement plans, is a creation of the federal Pension Protection Act of 2006. Prior to that Act, non-spouse beneficiaries of a qualified retirement plan often found that when they inherited a qualified retirement account, they could not defer the income taxes on the assets. This was mostly because the plan administrator would require that the account be liquidated much more quickly than federal tax law required, causing early recognition of income taxes on the pre-tax dollars contained in the account.

Nowadays, qualified plan administrators are required to allow designated beneficiaries to transfer the qualified account assets to Inherited IRAs. The benefit of transferring the assets to an Inherited IRA is that distributions from the account can occur over the beneficiary’s lifetime, spreading the income tax bite over many many years, and retaining the ability to invest pre-tax dollars. IRA accounts can also be transferred to an Inherited IRA.

There are some requirements to be followed when setting up an Inherited IRA. The Inherited IRA account must be titled in the name of the original account owner and the beneficiary, typically written as “IRA f/b/o John Doe, as beneficiary of John Public, Deceased.” The transfer to an Inherited IRA is not a true rollover of the account, it is a trustee to trustee transfer, meaning that the account cannot be paid directly to the beneficiary to then transfer into the inherited IRA. There is no sixty day rollover rule here. The transfer must be made directly to the Inherited IRA or you will have to immediately pay the income taxes. A further requirement is that Inherited IRA assets cannot be commingled with your own assets. Lastly, be sure to name your own beneficiaries for your Inherited IRA. If you pass away prior to withdrawing all of the assets, your named beneficiaries will be able to continue withdrawing the assets on the basis of your life expectancy.

If you are named as a beneficiary of a qualified retirement account or IRA, the decisions you make can have major financial repercussions, and can generate a significant and unnecessary income tax liability. The advice you may be receiving from the qualified plan administrator or IRA custodian may well be incorrect or out of date. In addition, the plan administrator or custodian may be a company that is not friendly to IRA beneficiaries and needlessly advises that plan or IRA accounts must be cashed in right away, without advising of the possibility of transferring the account to another IRA custodian as an Inherited IRA. If you are in this situation, you are strongly advised to consult with your lawyer or accountant as soon as possible. The income tax bite can be many tens of thousands of dollars, depending on the value of the account.

I need to add a disclaimer here: unfortunately, it is impossible to offer comprehensive legal advice over the internet, no matter how well researched or written. And remember, reviewing this website and my blogs doesn’t make you a client of my Firm. The rules regarding retirement accounts do change, are highly fact specific, and errors can be extremely costly. Before relying on any information given on this site, please contact a legal professional to discuss your particular situation.

Oh, and the IRS would like me to let you know that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.