If you find yourself with an inherited IRA, you should be aware of the potential tax implications of that gift. Whether you leave the money in the IRA or take it out – and when – depends on your unique financial situation, so it’s best to consult with a financial planner and tax professional who can help you determine the best path forward for you. When the money comes out of the IRA, it will be taxable at ordinary income rates for the recipient, so it’s important to understand how that may impact your taxes during any given year. You will need to set up your own inherited IRA account – since you’re not allowed to transfer it to an existing IRA – and while you’re at it, you may want to create a long-term strategy for how you’ll manage those assets moving forward.

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LEARN MORE ABOUT: IRA Accounts

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Inheriting an individual retirement account (IRA) can provide a significant amount of money for beneficiaries. However, it’s essential to understand the rules and regulations that govern inherited IRAs to avoid penalties and maximize the inheritance.

Here are some important things to know about inherited IRAs:

1. Inherited IRAs are different from traditional or Roth IRAs. Inherited IRAs don’t belong to the person who inherits them; they belong to the original account holder. The inheritor receives the rights to withdraw money from the account, but they must follow specific rules.

2. The type of IRA determines the distribution period. A beneficiary of a traditional IRA must start taking minimum distributions from the account by December 31 of the year following the account owner’s passing. The distribution amount is based on the beneficiary’s life expectancy and calculated each year.

3. Roth IRA beneficiaries aren’t required to take minimum distributions. A Roth IRA owner’s heirs don’t have to take RMDs as long as they leave money in the account for ten years after the primary account owner’s death. The money can be withdrawn before ten years, but taxes and penalties apply.

4. Spousal beneficiaries have additional options. A spouse who inherits an IRA may roll the account over into their IRA. If they’re younger than the primary account owner, it may delay the start date of RMDs.

5. Inherited IRAs can be a tax burden. Inherited traditional IRAs are taxed as income, which could place the heir in a higher tax bracket and increase their tax liability. Roth IRA earnings are tax-free, but if the account is withdrawn before ten years, the gains are subject to taxes and penalties.

6. Early withdrawals have penalties. Beneficiaries who withdraw money from an inherited IRA before age 59 ½ face the same penalties as those withdrawing from traditional IRAs. The withdrawn amount is taxed, and a 10% early withdrawal penalty applies.

7. Charitable donations are an option. If a beneficiary doesn’t need the money from the IRA, they can donate it to a charity of their choice. The inherited IRA is excluded from their taxable income, and the charity benefits from the donation.

In conclusion, inherited IRAs require careful attention to avoid penalties and tax liabilities. It’s essential to consult with a financial planner to ensure compliance with IRS regulations and maximize the inheritance.