What Is a Beneficiary IRA Account?
When a person dies and his IRA account is passed on to another person, this person is the beneficiary of the IRA. The beneficiary inherits the account and has options of how he handles the newly gained asset. Depending on the way the IRA was set up and what the beneficiary chooses, the tax responsibilities vary.
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Inherited from Spouse
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When a beneficiary of an IRA inherits the account from a spouse, the beneficiary has three choices. The beneficiary can treat the IRA as her own account by designating herself as the owner of the account. If the beneficiary does this, the account has the same priviledges and rules it did when the original owner had it. Contribution allowances remain the same as do distribution rules. The beneficiary can treat the IRA as her own account by rolling it over into a qualified employer plan, qualified employee plan, tax-sheltered annuity plan, or deferred compensation plan. Or the beneficiary can treat herself as a beneficiary of the IRA. If the beneficiary chooses this option, she cannot make contributions to the IRA nor accept distributions from it until the age of 70½.
Inherited from Someone Else
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If the IRA is traditional and inherited from someone other than a spouse, the beneficiary does not have the option to treat it as her own, and cannot make contributions to it and or make rollovers into or out of the IRA. Taxes and distributions are handled the same way as if the beneficiary was the owner; taxes are not paid until distributions are received.
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Stretch Plans
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In 2002, a tax code provision was made to allow for stretching of IRAs. In order to qualify for this, an IRA must be set up correctly by a professional in a will or trust. Stretching an IRA refers to avoiding paying large tax payments upon receipt of IRA. When a beneficiary receives an IRA, typically he is required to pay taxes on the IRA immediately. With this code, the tax payments are deferred until a later time.
Distributions
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Generally, IRA account holders start receiving distributions from the account by the age of 70½. If the IRA is inherited from a spouse, the beneficiary chooses whether to take distributions over a five-year period or over the course of her life. If the five-year option is chosen, all money must be taken within five years. If the lifetime option is chosen, distributions must start being made by the year the decedent would have turned 70½.
Lump Sum Option
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Beneficiaries always have the option of taking a lump sum when the IRA is inherited. Many beneficiaries choose this option only if they need the money immediately. This option carries a large tax liability, which reduces the amount the beneficiary receives.
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References
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