Is There a Penalty for Transferring an Inherited IRA?
An Individual Retirement Account (IRA) was created through the Employer Retirement Income Security Act of 1974 to help individuals save assets toward retirement. Those who have taken advantage of IRA savings find that the IRA may be the largest asset they own next to or even exceeding the value of the family home. This has led to the IRA not only being a savings tool, but a wealth transfer tool to help the next generation. Inheriting an IRA leaves you with many options of how to take the asset without penalty.
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Type of Inheritance
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The person inheriting the money plays a major factor in what can be done with the IRA. A surviving spouse is more options and flexibility than a child or non-related heir. When an estate or trust is named as the beneficiary, the IRA must go through the proceeding of probate or trust liquidation instead of being treated as a separate entity that inherently avoids probate.
Options
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A living person who inherits the IRA has four basic options. The first option is to take the money out in a lump sum distribution and pay taxes on it. The second option is to disclaim it; this is done most often by a surviving spouse looking to reduce her living taxable estate if she doesn't need the income from the IRA. The third option is to retain the IRA and remain a beneficiary on the IRA, stretching the IRA over time and reducing the taxes based on the beneficiaries life expectancy. The last option is to roll the IRA over into a new IRA account. A spouse has the option to co-mingle personal IRA funds with inherited funds.
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Post-Choice
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Once you have chosen what you want to do with the IRA, you are then responsible for the IRA distributions and management as if it were your own. So if you have chosen to roll the assets over into a personal IRA, you will not be taxed or penalized for the initial choice. The IRA is designated as an inherited IRA in the title. If you choose to transfer to a new custodian, the transfer is treated as any other IRA transfer. The title of the new IRA must match the title of the existing IRA, meaning it must be an inherited IRA. Doing so will prevent any penalties.
Sharing Beneficiaries
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Some IRA accounts have several named beneficiaries. This is common if there is more than one child in the family. The children may continue the IRA as one entity. However, the younger children may not receive the full tax benefit in this scenario since the required distributions will happen based on the age of the oldest beneficiary. If each child transfers the IRA out by Dec. 31 following the year of the owner's death, then they each have an IRA based on their own age.
Benefits
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The Internal Revenue Service (IRS) seeks to tax assets at least once per generation. The IRA is given special considerations where the taxes may be paid by reduced in over the course of the lifetime of the second generation receiving it. This is an important benefit for those trying to help establish a financial legacy. Instead of paying taxes upon inheriting the money, heirs can increase the value of the inheritance over time and transfer assets to new IRA investment plans that meet specific financial and investment goals--all without penalty.
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