The IRS has established rules for determining the minimum amount that must be withdrawn each year from an inherited traditional IRA. When an individual inherits an IRA, the rules differ somewhat depending on whether the individual was the decedent’s spouse. In any case, there is a substantial incentive for following the rules, because the failure to take minimum withdrawals results in a stiff penalty equal to 50% of the shortage. Since complying with the rules can be a convoluted process and a mistake could be costly, it makes sense to be guided by professional advice.
Surviving Spouses
The starting point is the general requirement that minimum withdrawals must begin at the age of 70 1/2. If an IRA owner dies before April 1 of the year after he or she turned 70 1/2, or at any earlier time, the surviving spouse can handle the IRA in any of three different ways. First, the spouse can transfer the account to his or her own name, so that it is treated as if it always belonged to the survivor. If the survivor is substantially younger than 70 1/2, this has the benefit of putting off mandatory withdrawals for years, during which time there will be more tax-deferred growth in the IRA. This choice also has the benefit of using a longer joint life expectancy figure in calculating the minimum withdrawals, meaning less is taken out and taxes are reduced.
Second, the surviving spouse simply can leave the IRA in the deceased spouse’s name and begin taking minimum withdrawals when the deceased spouse would have been able to do so. The third approach is to invoke the “five-year rule,” which allows the surviving spouse to do whatever he or she wants with the account until December 31 of the fifth year after the year in which the other spouse died. By that date, however, the account must be emptied and the resulting taxes must be paid. The five-year approach is not available if the deceased spouse died on or after April 1 of the year after turning 70 1/2.
Other Individual Heirs
If the deceased individual named a nonspouse beneficiary for the IRA, the beneficiary must begin taking minimum withdrawals over his or her own life expectancy, starting by December 31 of the year after the year in which the account owner died. Additional withdrawals must be taken by December 31 of each successive year. To calculate the minimum amount to be withdrawn, the beneficiary must divide the account balance for the previous year by his or her life expectancy, as given in tables published by the IRS.
As with surviving spouses, an heir can use the five-year rule to liquidate the inherited account by the end of the fifth year after the original owner died, before which time the heir can withdraw as little or as much as desired. Also as with surviving spouses, the five-year rule is not available if the IRA owner died on or after April 1 of the year after turning 70 1/2.