What Are My Options if I Inherit an IRA or Benefit from an Employer-Sponsored Plan?

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If you don't want the money, you can always disclaim (refuse to accept) the inherited IRA or plan funds. But if you're like most people, you will want the money. Your first thought may be to take a lump-sum distribution, but that's usually not the best idea. Although a lump sum provides you with cash to meet expenses or invest elsewhere, it can also result in a huge income tax bill (in most cases, due all in one year). A lump-sum distribution also removes the funds from a tax-deferred environment. Fortunately, you probably have other alternatives.

If you are the designated beneficiary (i.e., you are named as beneficiary in the IRA or plan documents), you can take post-death distributions over your remaining life expectancy, spreading out distributions over a number of years. This life expectancy calculation will give you the minimum amount you must withdraw from the IRA or plan each year (you can always withdraw more than required in any year). Yearly distributions from the IRA or plan must begin by December 31 of the year following the year of the owner's or participant's death. If there are other designated beneficiaries and separate accounts have not been set up, the oldest beneficiary must be used for the life expectancy calculation. (Note: An employer-sponsored retirement plan can specify the distribution method that beneficiaries must use.)

You may have other options as well. If the IRA owner or plan participant died before he or she began taking required minimum distributions, you can generally elect to distribute the entire interest in the IRA or plan within five years of the owner's or participant's death. (In this case, you don't have to begin taking distributions the year after death.) If the IRA owner or plan participant died after beginning to take required minimum distributions, you may be able to spread distributions over the owner's or participant's remaining life expectancy (calculated in the year of death) if that period is longer than your own life expectancy. (Be sure to first withdraw the RMD for the year of death, if not yet taken by the IRA owner/plan participant.) Again, however, keep in mind that an employer-sponsored retirement plan can specify the distribution method that beneficiaries must use. If your choices are limited by a plan, you may have the ability to transfer the plan funds to an IRA established in the deceased IRA owner's or plan participant's name--the rules that apply to inherited IRAs would apply to the transferred funds.

You may also have additional options if you are a surviving spouse and a designated beneficiary of the IRA or plan. You can roll over inherited traditional IRA or plan funds into your own traditional IRA or retirement plan. If you're the sole beneficiary you can also leave the funds in an inherited IRA and treat it as your own IRA. In either case you can then name beneficiaries of your choice and defer taking distributions until the required age (usually 70½). You can generally also roll over ("convert") non-Roth distributions from an employer plan into a Roth IRA (you'll generally pay tax upon the "conversion" but qualified distributions from the Roth IRA will be tax free).

If you're a nonspouse beneficiary, you generally have far fewer options. For example, you can't roll over a distribution from an employer retirement plan into your own IRA or plan account but you can generally directly roll the distribution over into an inherited IRA (complex rules apply). Like spouse beneficiaries, you can also roll over ("convert") non-Roth distributions from an employer plan into an inherited Roth IRA (however, you must do so in a direct rollover).

Certain restrictions apply to rollovers, however. For example, you cannot roll over required minimum distribution amounts (i.e., distributions required in the year of death). Also, inherited Roth IRAs can only be rolled over into a Roth IRA, and inherited Roth 401(k)/403(b)/457(b) accounts can only be rolled into another Roth 401(k)/403(b)/457(b) account that accepts rollovers, or into Roth IRAs.

Finally, Roth IRAs are subject to similar rules. If you inherit a Roth IRA, you can take distributions over a five-year period (following the Roth IRA owner's death) or over your remaining life expectancy. If you are a surviving spouse beneficiary, you may be able roll the assets over to your own Roth IRA or, if you're the sole beneficiary, treat the Roth IRA as your own. This is significant because, as a Roth IRA owner, you do not have to take any distributions from the Roth IRA during your life. Distributions from an inherited Roth IRA are usually free from income tax if made at least five years after the deceased IRA owner first contributed to any Roth IRA (other than an inherited Roth IRA).

Caution: When evaluating whether to initiate a rollover always be sure to (1) ask about possible surrender charges that may be imposed by both the distributing plan and the receiving plan, (2) compare investment fees and expenses charged by your IRA (and investment funds) with those charged by your employer plan (if any), and (3) understand any accumulated rights or guarantees that you may be giving up by transferring funds out of an employer plan. The rules governing inherited IRAs and employer-sponsored plan accounts are complex. Consult a tax advisor for more information.

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This material is provided for general information purposes only and is not a recommendation or solicitation to buy or sell any particular security, product or service. Past performance is not indicative of future investment results. Any investment involves potential risk, including potential loss of capital. Before making any investment decision, please consult your legal, tax and financial advisors. Non-deposit investment products are not bank deposits and are not insured or guaranteed by Canandaigua National Trust Company of Florida, or any federal or state government or agency and are subject to investment risks, including possible loss of principal amount invested.

Tax information presented is not to be considered as tax advice and cannot be used for the purpose of avoiding tax penalties. Neither Canandaigua National Trust Company of Florida nor its affiliated Companies provide tax, legal, or accounting advice. Please consult your personal tax advisor, attorney, or accountant for advice on these matters.

Posted by Kelly Hohman at 10/17/2016 08:31:04 PM