How to rollover an inherited IRA

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(MoneyWatch) A few days ago I wrote about how to inherit an IRA. If you are the son, daughter, brother, sister, or even a non family friend of an IRA owner who has named you as their beneficiary, then you need to understand the rules that govern IRA inheritances.

As a non-spouse beneficiary, you do not have the option of rolling the assets into your own IRA. If you inherit IRA assets from someone other than your spouse, you generally have two options from which to choose: direct transfer of the IRA to a special type of IRA called an inherited IRA, or take cash distributions as taxable income. For most people, the direct transfer to an inherited IRA is the better option. To do this, here are the steps to take.

Open an Inherited IRA:

An inherited IRA is a special type of IRA which is commonly called a Beneficiary Distribution Account IRA, or BDA IRA. When you establish an inherited IRA, it's important that the IRA custodian registers the account properly. The account registration should include:

  • the name of the person who died;
  • an indication that the account is an IRA beneficiary distribution account;
  • the inheritor's name.

Different IRA custodians may have varying interpretations of the IRS's rules regarding account registrations and therefore may require all of some of this information.

Request a trustee-to-trustee transfer:

Make sure that any assets transfer directly from one account to another or from one IRA custodian to another. There is no option for a 60-day rollover when inheriting IRA assets. If you receive a check, the money will be taxed as ordinary income, and is ineligible to be deposited into an inherited IRA you may own at another firm. Also, once you take a check it cannot be deposited back into the inherited IRA that it was withdrawn from to begin with.

A separate minimum required distribution will be required if the original IRA owner was 70 1/2 or older at the time of his or her death and he or she didn't take the first MRD before passing away. If that's the case, this money must be distributed to you after transferring the rest of the assets to an inherited IRA in your name. Also, it must be distributed by December 31 of the year in which the IRA owner died. The amount of that MRD will be based on the IRA owner's age, but the assets will be distributed to you under your Social Security number. Contact the IRA custodian to inquire about how it handles "year-of-death" distributions; as how this is processed at different firms can vary.

Once the assets have been transferred to an inherited IRA in your name, you have two options: leave the assets in the account or take cash distributions.

If you don't have an immediate need for the money, leaving the assets in the inherited IRA until minimum distributions are required may be the best because the longer you keep the money in it the longer you will enjoy tax-deferred growth. On the other hand, when you take money out of an inherited IRA, it will be taxed as ordinary income. The more you withdraw from an inherited IRA now, the less it will be worth in the future

Disclaim the Inherited IRA.

If you decide that the IRA is too small for you to deal with or you would rather your share of it go to other beneficiaries, then you can decline to accept all or part of the IRA assets you are entitled to. If you do this, your share of the IRA will pass to the other eligible beneficiaries. If no other beneficiaries exist, the assets will pass to the original IRA owner's spouse and then to the estate. A decision to disclaim IRA assets must be made within nine months of the original IRA owner's death and before you take possession of the assets. Declining your share of an IRA is an irrevocable decision.

  • Ray Martin

    View all articles by Ray Martin on CBS MoneyWatch»
    Ray Martin has been a practicing financial advisor since 1986, providing financial guidance and advice to individuals. He has appeared regularly as a contributor on the CBS Early Show, CBS NewsPath, as a columnist on CBS Moneywatch.com and on NBC-TV's morning newscast TODAY. He has also appeared on the Oprah Winfrey Show and is the author of two books.

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