Caution! No Rollover for Nonspouse Beneficiaries
By Sarah Brenner, JD
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Did you inherit an IRA from someone who is NOT your spouse? This is not uncommon. Maybe you inherited from a sibling or a parent or a friend. If this is your situation, you will want to proceed with caution. For nonspouse beneficiaries a wrong move can result in disastrous consequences. So, take your time and do it right.
Step one is to carefully explore your options. What are a nonspouse beneficiary’s options when it comes to the inherited IRA?
Under the tax code, nonspouse beneficiaries can take advantage of the “stretch” IRA. This means you can set up a properly titled inherited IRA and then take required minimum distributions (RMD)s based on your life expectancy. By using this option, you can keep your inherited IRA for years and continue tax-advantaged growth. By taking only the RMD each year you can minimize the tax impact of the IRA distribution.
In some cases, the IRA document will limit the options available. You should consult with the custodian of your inherited IRA and review the IRA document to see what possibilities are offered. Most IRA documents will provide all the options available under the law, including the stretch, but not all do.
When you inherit an IRA as a nonspouse, you should proceed with extra caution. “Touch nothing!” is good advice. Give serious thought to what you want before doing anything. A nonspouse beneficiary who takes a distribution without understanding the tax consequences has no remedy. A nonspouse beneficiary, unlike a spouse beneficiary, does not have the choice of rolling over an unwanted distribution. If you take a full distribution with the intent of rolling it over, the ability to stretch distributions from the inherited IRA will be lost forever. Nonspouse beneficiaries do have the ability to move an inherited IRA to a new custodian, but the move must be done by a direct trustee-to-trustee transfer.
Example: Tom named his three children, Lisa, Eric and Natalie, as beneficiaries of his IRA. Lisa and Eric consult with financial advisors and set up inherited IRAs. They do not take distributions from these IRAs. There is no taxable event and Lisa and Eric have not lost their ability to stretch out distributions over life expectancy. Natalie does not consult with an expert and takes a lump sum distribution from her inherited IRA. The distribution is taxable to Natalie and she has lost the stretch. There is no remedy for Natalie if she has second thoughts.
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