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When You Inherit an IRA


March 30, 2012

Question:  My Grandfather left me one of his IRAs –I haven’t done anything with it, yet, but someone said I had to be very careful to not give in to the desire to cash it in.  Can you tell me what I should do?

Answer:  The very first thing to consider when you learn that you have inherited an IRA is – don’t do anything until you have learned all you can about exactly what you have inherited. There are several different sets of rules and you need to know which rules apply to you.

Above all, make sure you have received and seen formal, documented proof that YOU are the beneficiary. If your grandfather told you that he would be leaving his IRA to you, even if he expressed that wish in a letter he sent you or a note he scribbled on his deathbed, you need to make sure that the beneficiary form he completed for his IRA says the same thing.  If you are named as the beneficiary of his IRA, you may simply be able to roll the money over to your own IRA without penalty.  However, when you are not the spouse of the decedent, there are some pretty significant rules that need to be followed.

The custodian of the IRA will have a copy of the beneficiary designation set up by your grandfather. If he listed you – with your full, legal name - as the only beneficiary, and you can satisfactorily prove to the custodian that you are indeed the person named, you will be able to take ownership of the IRA. If you want to move that IRA into an IRA account that you have established with a different custodian, you will need to rename it, including your grandfather’s name as the original owner and stating that it has been inherited. For instance, if the IRA had been named “Fred’s IRA”, you could name it “Fred, deceased, inherited IRA, FBO (which means, “for the benefit of”) Fred Jones III, beneficiary.” But DO NOT have it re-titled in your own name. If it is re-titled in your name, it probably will result in the value of the IRA being included as current income in the year the re-titling took effect. You should avoid this, as it could potentially push you into a different tax bracket.  It also might trigger a 6% tax penalty for excessive IRA contributions.

But what if there is no beneficiary form on file? Heirs will find themselves at the mercy of the IRA custodian’s default policy. Typically, the default will be to award to a living spouse first.  Unfortunately, if no valid beneficiary designation can be found, and there is no living spouse, your grandfather’s IRA will most likely become part of his entire estate, which carries a host of other potential problems like required minimum distributions (RMD) situations. If there is no beneficiary form on file, the resulting situation will probably require you to seek advice from a licensed financial advisor.

The key factor is to make sure that the IRS can never consider the money is a liquid asset that is totally in your hands, because you would then most likely be subject to full taxation.

To reach a professional preparer and get details on the tax consequences of inherited IRA’s, call PRO-TAX at 434-220-4705, or check this web page for the location of the nearest PRO-TAX office.