Inherited IRA Distributions and Taxes: Getting it Right
If you have inherited an IRA account from a parent or any other relative that named you a beneficiary of the account, rest assured that you don’t need to turn your IRA account over to the estate — regardless of what the will says or how the executor of the will interprets the will.
If the will asks for “cash on hand” to be distributed among family members, this does not include the IRA account. “Under no circumstances would you be required to provide the executor with the proceeds from the IRA.
The beneficiary designation, assuming it names you directly, supersedes any provision in the will. Even if the will said you leave my IRA rollover or my IRA to my estate, the beneficiary designation takes precedence. (See also: Distribution Rules for Inherited Retirement Plan Assets.)
This is good advice to keep in mind when considering beneficiaries of your IRA or 401(k) account. The designation of a primary beneficiary is of the utmost importance. Whether it is your spouse or your child/children you want to leave your IRA account to, designating them as beneficiaries is necessary. Another important thing to remember is to keep your IRA and 401(k) beneficiary list up to date as your family circumstances change.
The will that asks for “cash on hand” to be distributed among family members refers to probate assets of the descendent. “Assets that pass by beneficiary designation are not probate assets, and are therefore not subject to the terms of the will,” said Michael Delgass, financial advisor with Sontag Advisory in New York. “An IRA account is the most common example of this kind of asset. These assets have a contractual agreement with the entity holding them (here, the custodian of the IRA) that require that entity to pay them out the beneficiary.”
Cash on Hand
IRAs, and by default, inherited IRAs are tax-deferred accounts. That means that tax is paid when the holder of an IRA account or the beneficiary, in the case of an inherited IRA account, takes distributions. IRA distributions are considered income and as such are subject to applicable taxes. If the will refers to “cash on hand” to be distributed among family members, IRA distributions would not be considered “cash on hand.”
“Cash on hand refers to readily accessible cash, and since IRA distributions are taxable, I would personally not include that in COH,” said Adam Harding, a financial advisor in Scottsdale, Arizona. (See also: 3 Deadlines for Retirement Plan Beneficiaries.)
In the case of inherited IRAs the primary beneficiary designation takes precedence over any directions in the will. If the executor of the estate asks the IRA primary beneficiary to hand over the IRA back to the estate that is not a proper action to take. You, as a primary beneficiary, have all the rights to inherit your ancestor’s IRA.
If you were to actually cash out the inherited IRA and give it to the estate you would pay taxes. “If you should cash in [the] IRA and hand it over to her estate, you would be forced to pay taxes on it on top of losing your inheritance,” said Arie Korving, a financial advisor with Korving and Company in Suffolk, Virginia.
The Bottom Line
Keep your inherited IRA and be aware of distribution policies and taxes on those distributions. Inherited IRAs either need to be distributed within five years of receiving them, or that time period can be extended so that inherited assets can be distributed over the beneficiary’s life expectancy. In either case, distribution from an inherited IRA is considered income and taxed accordingly. (See also: 11 Things You May Not Know About Your IRA.)