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Inherited IRA Accounts
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What happens if a relative passes away and you suddenly inherit an IRA account? Do you pay tax on the value of the account when you inherit it? Should you just transfer the funds into your own IRA, or should you keep the account separate?

How you handle your new IRA account depends on your relationship to the person who died and whether that person had started taking distributions out of the IRA before death.

If You Inherited the IRA from Your Deceased Spouse You can choose to treat the IRA as your own, if your spouse hadn't previously inherited the IRA from a former spouse.



You have several options:



You can roll over your spouse's IRA into your own IRA.
You can ask your spouse's IRA trustee to make a trustee-to-trustee transfer of the IRA directly into your IRA.

You can make contributions (including rollover contributions) to the inherited IRA. After you take over the IRA, you're treated as the owner of the IRA account, and all the normal rules apply to this IRA just as they would to an account you set up yourself. This means that for the most part, you can't take distributions out of the IRA before you reach age 59 1/2 without getting stuck with a 10 percent penalty. Some exceptions to this penalty rule exist, so be sure to check these out in http://www.irs.gov/pub/irs-pdf/p590.pdf?source=ttcommain" IRS Publication 590, Individual Retirement Arrangements to see if they apply to you.

If you don't take any of these actions, to take over the IRA as your own account, you need to follow the rules described next for someone who inherits an IRA from someone other than their spouse.




If You Inherited the IRA From Someone Other Than Your Spouse

In this situation, you can't treat the inherited IRA as your own IRA account. This doesn't mean that the money isn't yours; it simply means that you can't make any contributions to that IRA or roll it over to another IRA.




Does the money just sit there? Not necessarily. In fact, you may be required to take money out of the IRA.

How The Situation Works
If the decedent was taking distributions out of the IRA under the minimum distribution requirements when he or she died, then you must start taking money out using the same distribution method. Ask the decedent's IRA trustee for this information.

If the decedent wasn't taking distributions out of the IRA, you have two options for receiving the distribution from the IRA account:

All of the interest from the IRA must be distributed to you by December 31 of the fifth year after the year the decedent died, or All of the interest must be distributed over: Your life, or A period of time limited to your life expectancy.

Which one do you use? The actual IRA document may choose an option for you or state that the owner of the IRA or the beneficiary can choose. If you get to choose, you usually must do so by December 31 of the year after the IRA owner's death.

If the IRA document doesn't specify an option, or if you don't specifically choose one, you have to take the entire distribution out according to the first rule above (by December 31 of the fifth year after the year of death).

If you're not sure exactly what amount you're supposed to take out of your inherited IRA, ask the IRA's trustee to help you figure this out.




How You Are Taxed

You do not have to pay taxes on the account at the moment you inherit it. But from that point on, you'll be taxed depending on how you chose to treat the IRA, and on your relationship to the decedent.

If You're the Surviving Spouse Who Inherited the IRA

If you chose to treat the IRA as your own, then you report distributions from the inherited IRA account just as if it were your own IRA, and you include the inherited IRA account with your own accounts to determine the taxable amount of your withdrawals.

If you or your spouse made nondeductible contributions to any of your IRA accounts (that is, more money than you were allowed to contribute tax-free, given your income at the time), then you have a tax basis in your IRAs, and you must use http://www.irs.gov/pub/irs-pdf/f8606.pdf?source=ttcommainForm 8606,

Nondeductible IRAs to figure out the taxable amount
of the distributions.

How IRA Distributions Are Taxed.


If you simply rolled the inherited IRA over into your own IRA account, you're
not taxed.

If You're Not the Surviving Spouse

You'll need to keep the inherited IRA in an account separate from your personal IRAs.


If you took money out of the IRA account that you inherited, and that IRA had a "tax basis" (meaning that the original owner made nondeductible contributions to it), then you calculate the taxable amount on href="http://www.irs.gov/pub/irs-pdf/f8606.pdf?source=ttcommain"
Form 8606

Important: If you took money out of your own IRA accounts in addition to the money you took out of the inherited IRA, and you made nondeductible contributions to your own IRA in the past, you must use two different Forms 8606 to figure out the taxable amounts: one for the inherited IRA account and another for your own IRA account(s). Don't combine your own IRAs with the inherited one when you calculate your taxable distribution.



You'll need to obtain the decedent's tax basis information from the last Form 8606 filed with his or her tax return. Ask the executor of the estate for this information.



Don't hesitate to consult a tax professional if your IRA distribution situation seems overwhelming. Take the right steps now so you can minimize your tax bite now and in the future.



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Before you learn about stretching your Inherited IRA, you need to understand IRA basics.  IRAs have been around for years.


Traditional IRAs allow you to invest a certain amount of before-tax earnings on a yearly basis. That reduces your current taxes because you don’t pay taxes on that money until you actually take it out later. The main benefit of your IRA is that it grows more quickly because you aren’t taking money out to pay taxes.


Company retirement programs like 401(k)’s work similarly. Sometimes companies will match a portion of their employees’ contributions, dramatically increasing the employee’s return. If your company matches any of your contribution make sure you take advantage of it!  When you change jobs or retire you can transfer the money from your 401(k) into your own IRA.


Roth IRAs allow you to invest after-tax dollars, but the earnings on a Roth IRA are never taxed.  You aren’t required to start taking money out of a Roth IRA at age 70 ½ like as in a traditional IRA.