What is an Inherited IRA?

An inherited individual retirement account (IRA) is a retirement account that someone inherits after the account holder passes away. The rules for inheritance are different for spouses and non-spouses. People with IRAs who want to add clauses to their will about how their retirement accounts should be handled in the event of death may want to talk both to intended beneficiaries and financial planners. Paperwork may also need to be filled out with a financial institution to provide information about the beneficiary of the IRA.

When a spouse inherits an IRA, he or she has the option of rolling the IRA over into existing accounts and transferring it into his or her name. It is also possible to make contributions into the inherited IRA. If the original holder of the account had started to receive payments after retirement, these payments would be redirected to the beneficiary.

Non-spouses also can inherit IRAs. People can choose to leave an inherited IRA to children, parents, or other beneficiaries. In this case, the beneficiary cannot roll over or contribute to the IRA, and cannot transfer it into his or her name. The beneficiary has the option of distributing all of the funds in the inherited IRA within five years of the original account holder's death, or of receiving regular benefit checks based on length expectancy.

There are tax benefits available with IRAs, but the accounts need to be handled properly for people to access those benefits. People can consult tax attorneys or financial planners to get information about how to access the tax benefits and how to avoid triggering problems with an inherited IRA. Generally, people do not need to pay taxes on the funds until they are distributed, and they do not pay a penalty for early distribution if they are below retirement age when they start receiving payments, unless they violate the rules. Violations will result in increased tax liability and can cause considerable paperwork as well.

Financial institutions allow people to designate beneficiaries on their accounts, including IRAs. Depending on how an inherited IRA is structured, the beneficiary may be allowed to choose between the two distribution methods, or one method may be triggered automatically at death. To avoid confusion, people who have designated beneficiaries on their bank accounts usually also discuss the disposition of these accounts in their wills to make their intent clear. If a change needs to be made, it is important to confirm that the information at the bank and in the will has been changed.