Owners of Traditional IRA’s must start taking Required Minimum Distributions when they turn 70 ½ years of age. When a person, other than a spouse, inherits an IRA, they must start RMD (Required Minimum Distribution) the year following the year the owner died. The persons inheriting will have to pay tax on distributions of deductible contributions and earnings from a traditional IRA. Not taking an RMD results in a 50% penalty on the amount that should have been withdrawn for the year. However, you may avoid the penalty if you miss an RMD by emptying the account within five years of the owner’s death. This depends on the size of the IRA and age of the beneficiary. In some instances, it may be smarter to pay the penalty than to withdraw the money from the IRA account. Also important is that if the owner of the IRA died before starting the RMD’s but had not taken the RMD for the year in which he or she died, that RMD must be withdrawn from the account. There is a different requirement for Roth IRA’s. The owners never have to take RMD’s, however, non spouse beneficiaries must take RMD’s. The good thing is that the withdrawals from inherited Roth IRA are still tax free.
Another caveat is that non-spouse beneficiaries cannot roll an inherited IRA into their own IRA. In those instances, a separate account should be created.
Finally, when there’s more than one beneficiary of the IRA, it’s important that they split the IRA among the beneficiaries to take advantage of the beneficiaries individually ages. If not, the age of the oldest beneficiary will be used to calculate the RMD’s now which generally will shorten the number of years the money can grow tax deferred.
When the situation arises, it is advisable that you consult with either your attorney, your tax accountant or financial planner to insure that the maximum benefits can be derived from an inherited IRA.