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IRA Withdrawal Rules For A Beneficiary

Individual Retirement Accounts come with many designations and qualifications as outlined by IRS guidelines which enables their tax free or tax deferred status. If an IRA is inherited as a duly noted beneficiary it is important to understand how various guidelines and tax issues may apply to you. If you understand these rules then as an IRA beneficiary you may be able to avoid tax liability or penalties.

As an IRA beneficiary, the tax deferred status can be maintained on the account if the inherited Traditional IRA is rolled over or transferred to a beneficiary IRA. As with any accounts inheritance it is always possible to liquidate the funds and take possession but at that point it will be considered earned income by the Federal government and taxed at your personal income tax rate.

As with many other benefits of marriage, the spouse of a deceased IRA account holder has the option to treat the inherited IRA has their own by rolling the funds over into a preexisting Individual Retirement Account. Since the IRA is now considered the spouses for tax and legal purposes, the funds continue to grow in the IRA as normal until mandatory minimum disbursements are required by law.

If the deceased IRA account holder was younger than 70 1/2 years at the time of death then there are a few more options available to the spouse on how to treat the Individual Retirement Account proceeds. One option is for the spouse to begin receiving disbursements by the end of the year the deceased would return 70 1/2 years old. However, another option is to withdraw the funds from a beneficiary IRA within a five year period of the time of death.

There are limitations however for a spouse who wishes to set up the beneficiary IRA. If the decedent was older than 70 1/2 at the time of death then the five year withdrawal option is no longer available. At that point, minimum mandatory withdrawals are required and are based on the spouses life expectancy. The spouse is also not permitted to make any additional contributions to an inherited IRA.

Inherited Roth IRAs are slightly different in that the beneficiary IRA can be established for both spouses and non-spouses. There is also the benefit that an inherited Roth IRA can continue to grow tax free for over the course of the beneficiaries lifetime which does not apply to traditional inherited IRAs. If the inherited Roth IRA is less than five years old and the funds are withdrawn in a lump sum than the proceeds will be taxed as ordinary income.

Individual Retirement Accounts by their very nature have conditions and complexities that must be fully understood to avoid penalties and taxes. This is no different when a retirement account is inherited by a beneficiary or spouse. Speaking with an accountant or tax professional is recommended to avoid any financial missteps by paying taxes or penalties unnecessarily.