If you inherit an IRA and are not a spouse of the deceased you have two choices:
- You can cash it in and pay income taxes on the proceeds, or…
- You can defer the taxes on it and allow it to grow tax deferred.
An Inherited IRA (also known as a Beneficiary IRA) differs from a regular IRA and the two should not be combined. A key difference between the two types of IRAs is how Required Minimum Distributions (RMDs) are calculated. Specifically, a different IRS table is used (the Single Life Table) to calculate the first year’s RMD from an Inherited IRA, and this initial calculation is used for the calculation of RMDs in subsequent years.
A second difference is that you are not required to take RMD distributions from a regular IRA until you turn 70 ½. However, you are required to take an RMD from an Inherited IRA by the end of the year after you receive it. This is true no matter the age of the deceased or the beneficiary’s age.
The amount of the RMD is based on value of the IRA at the end of the previous year and the age of the beneficiary. The rules can get quite complicated and it’s usually a good idea to consult a professional to insure that you don’t run afoul of the IRS. Penalties for not taking the RMD can be as high as 50%.