Rollover of an inherited IRA when the beneficiary is not the spouse

April 09, 2015 by Frank Thomas
Green sign that says Retirement Next Exit

You just found out your Uncle Jerry passed away and that he had listed you as the sole beneficiary to his traditional IRA account. You go down to the bank where your uncle had his IRA and take the money out, requesting that the bank close the account. After the bank is satisfied that you are the sole beneficiary and that your uncle is deceased, the bank issues you a check for the balance in your uncle’s IRA account. You then take the check to your bank and deposit the funds into your own traditional IRA account. After all, you heard IRAs can be rolled over, so you should be fine, right? Well, sorry to say, but no. You do not have a qualified nontaxable rollover. In fact, you don’t have a rollover at all.

There are very stringent rules that must be followed to rollover an inherited retirement account when the owner of the account was not your spouse. In the Uncle Jerry situation, for example, you are considered to be a nonspouse beneficiary, and, while it is possible to rollover your uncle’s IRA account, you must follow very specific procedures in order for the rollover to not be taxable.

A non-spouse beneficiary may rollover the IRA account of a deceased owner if the rollover is completed by direct transfer − also referred to as a trustee-to-trustee transfer − to an inherited IRA specifically established to receive the rollover funds. A direct transfer is when you have made an arrangement in advance between both financial institutions to transfer the funds and you do not actually take possession of the money in any form.

The newly created inherited IRA must be established in a manner that identifies it as an IRA with respect to a deceased individual in addition to identifying the deceased individual and the beneficiary. For example, the inherited IRA account is titled, “Jack White as beneficiary of John Doe (deceased).” In addition, you generally cannot make any additional contributions or rollovers into or out of the non-spouse inherited IRA.

What happens if you do not follow the proper procedures of either the trustee-to-trustee transfer or properly titling the new account, such as in Uncle Jerry’s situation? Well, the money deposited into your own IRA is not considered to be a qualified nontaxable rollover, and in such a case the money withdrawn from Uncle Jerry’s IRA is considered taxable, assuming your uncle had no after-tax contributions (basis). And the money from Uncle Jerry’s IRA that you deposited into your own IRA is considered your IRA contribution, and if the amount deposited exceeds your contribution limit for the year, any excess is considered an excess contribution, which is subject to 6% penalty tax each year the excess remains in the IRA account. In this example it is very likely too late to do anything about it, other than withdrawing the excess contribution so it doesn’t keep generating the 6% penalty tax.

But for you it may not be too late! If you do inherit an IRA from someone other than your spouse, be sure to properly transfer the IRA if you want to avoid being taxed on an inherited IRA account. Also, please note that there are very stringent required minimum distribution (RMD) requirements pertaining to an inherited IRA that must be followed as well.

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