Mat Sorensen


November 11, 2014

If you’ve inherited an IRA, 401(k), or other qualified retirement plan from a parent, family member, of friend, you have three options on how to receive the retirement plan funds. Each option comes with different tax ramifications and benefits. I’ll outline the three options below. Keep in mind, that if you have inherited a retirement account from a spouse, you can roll those funds over into your own IRA by doing a spousal rollover. I’ve written previously on that option here. Here’s the options though when the account is being inherited from someone other than a spouse.

1.Take the Money as a Distribution. If you just take the funds from the IRA or  as a distribution, you will receive a 1099-R from the IRA custodian and will need to report that distribution as income on your tax return. As a result, this is not the best option. While you will get access to the funds, you’ll also be taking in a large sum of income all in one-year and that can cost you a lot in taxes.

2. Transfer the Money to an Inherited IRA. The retirement plan funds are rolled into an inherited IRA where you are the beneficiary and can take distributions as you desire over time. The benefit to the inherited IRA is that the money stays as retirement plan funds and can continue to grow tax-deferred. The funds in the IRA must begin being distributed over time under what are known as required minimum distributions (RMDs). The good news is that you aren’t taxed on the full amount now but are taxed on it over time as you take distributions. In general, you take distributions using your life expectancy, which is typically longer than that of the deceased account owner and as a result you are stretching out the tax-deferred status of the account and only take distributions and pay taxes on the required minimum distribution amounts which can be 5% of the account depending on your age and life expectancy. The rules can be a little tricky as to RMD but are outlined here by the IRS.

3. Disclaim the Funds so They Go to an Alternate Beneficiary. This option allows you to disclaim your interest in the IRA to another beneficiary. This may be done if one child would rather inherit retirement plan funds while one would rather inherit other assets. The beneficiaries could make an arrangement where one disclaims their interest in the retirement account to another beneficiary. Also, a child may disclaim their interest so that it passes to their grandchildren. This is all governed by the beneficiary designations so make sure you review them and speak to an attorney before making a disclaimer.

If you are inheriting a retirement plan, consult with your tax or estate planning adviser as to the distribution rules and consider using an inherited IRA to stretch out the tax-deferred status of the account. This will allow funds to grow tax deferred, will give some income over time (RMDs), and will reduce your tax liability. And lastly, keep in mind that there are time-sensitive deadlines to follow for these options so don’t let the issue linger.


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