Nonspouse IRA Beneficiaries

It is increasingly common for individuals to inherit IRAs. By inheriting an IRA, we mean that you become entitled to some or all of the balance in a deceased account owner’s traditional IRA or Roth IRA by virtue of being designated as an account beneficiary.

In this scenario, you may think your share of the inherited IRA balance can be distributed to you and then rolled over tax-free into your own IRA before the familiar 60-day deadline for rollovers has passed. While this seems like a reasonable assumption, it is wrong—unless you are the deceased IRA owner’s surviving spouse. In other words, only a surviving spouse is allowed to roll over a distribution from an inherited IRA into his or her own IRA. Nobody else can.

Fortunately, there are ways to finesse the “no-rollover-allowed rule” so that you can take control of your share of an inherited IRA without adverse tax consequences. However, to make this strategy work, you must follow some important rules, one of which is that you cannot receive a distribution check payable to you personally from the inherited IRA. If you do so and you are not the deceased IRA owner’s surviving spouse, you cannot put the money back into an IRA and continue earning tax-deferred income (or tax-free income, in the case of an inherited Roth IRA). Furthermore, if you are not the deceased IRA owner’s surviving spouse, you must include it in your taxable income. Depending on the circumstances, a distribution from a Roth IRA may result in taxable income as well.

A nonspouse beneficiary can, however, make a direct (trustee-to-trustee) transfer of an inherited IRA into a specially titled receiving IRA that is still in the deceased account owner’s name (e.g., First Bank, Custodian for Jack Jones, Deceased, Jane Smith, Beneficiary). This does not count as a rollover for purposes of the no-roll-over-allowed rule. The receiving IRA must be a brand-new IRA set up for the specific purpose of receiving the inherited IRA. It cannot be combined with other IRAs. When the inherited IRA is a traditional IRA, the receiving IRA must be a traditional IRA. When the inherited IRA is a Roth IRA, the receiving IRA must be a Roth IRA. Required Minimum Distributions (RMDs) will generally need to be made over the beneficiary’s life expectancy starting the year after the IRA owner’s death.

By taking advantage of this favorable rule, the balance in an inherited IRA with a sole beneficiary, who is a nonspouse, can be transferred tax-free into a receiving IRA controlled by the beneficiary. Similarly, an IRA with several nonspousal beneficiaries can be transferred tax-free into several receiving IRAs, one for each beneficiary. Thus, each beneficiary can pursue his or her own investment strategy with the inherited money.

Please contact Martini, Iosue & Akpovi by phone at (818) 789-1179 if you have questions or want more information.


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