Taxation of IRA Distributions to Secondary Beneficiaries
If you inherit an IRA but are a secondary beneficiary (not the spouse of the original account owner), you must obey certain rules regarding distribution of the account's funds. These rules differ significantly from distribution to a spouse. Failure to comply with these rules comes with a stiff penalty from the Internal Revenue Service.
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Five-Year Rule
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You may elect to take the IRA funds over a period of five years. You must take your first payment the year after the original account owner dies, withdrawing the full account balance after five years. If you elect this distribution method, you may also take a full distribution anytime within the five years.
Lifetime Withdrawals
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You may elect to take lifetime withdrawals. In this case, the payments will be based on your life expectancy when you receive the IRA. Your IRA withdrawals cannot be stopped once they have started, and all proceeds must be distributed over your lifetime. You are not allowed to pass on any IRA funds to your heirs.
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Limitations
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There are limits to what you may do with an IRA you inherit. You cannot treat it as your own IRA. You cannot roll the IRA into an IRA that you own. You also are not allowed to make contributions to the account. With spousal distributions, the spouse is allowed to treat the IRA as her own IRA, adding to it, investing the proceeds and making withdrawals as needed. As a secondary beneficiary, you are only allowed to invest the proceeds accordingly and take funds from the account.
Warning
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If you fail to take funds from the account as required, you are charged a 50 percent penalty by the IRS. This penalty is charged on the amount of money you should have taken from the account but did not. Every year that you fail to take the required amount, you are assessed a 50 percent penalty on the amount you failed to take. This penalty stops when you take the required distribution amount.
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