Individual retirement accounts are designed to help people set money aside to increase financial security later in life, but IRA owners don't always live long enough to use all of their savings. If an IRA owner passes away before withdrawing all of the funds from the account, the remaining assets pass on to the account's beneficiary. IRA beneficiaries have a few different options when it comes to taking cash from an inherited account.


Opening an Inherited IRA

Any individual who inherits an IRA has the option of setting up an Inherited IRA to distribute the funds. An Inherited IRA is an account set up in the name of the original account holder for your benefit. You have to make required minimum withdrawals from an inherited IRA over the course of your life based on your life expectancy. If the original account owner was under age 70 1/2, you can delay withdrawals for up to 5 years, but you have to withdraw the entire balance of the account after the fifth year if you choose to delay. Withdrawals are taxed as ordinary income subject to your normal income tax rate.

Taking a Lump Sum

If you don't want to wait to receive cash from an IRA you inherit, you can cash out the entire balance of the account in a single lump sum withdrawal. Taking a lump sum avoids the complications of setting up an Inherited IRA or transferring funds to a different account. When you take a lump sum, the entire withdrawal is treated as taxable income in the year you receive it, which could move you into a higher income tax bracket and result in paying more taxes than you would if you opened an Inherited IRA.

IRA Transfer

When you inherit an IRA from a spouse, you have the option of transferring the funds to your own IRA or designating yourself as owner of the account. Taking ownership of an inherited account gives you the freedom to choose when to make withdrawals, instead of being forced to take withdrawals based on your life expectancy. When you take ownership of an IRA, you are subject to all the normal rules that apply to IRA owners, such as a 10 percent early withdrawal penalty if you tap into the account before age 59 1/2.

Roth IRAs

Your options when inheriting a Roth IRA are the same as those available when you inherit a traditional IRA: you can open an Inherited IRA, take a lump sum payment or take ownership of the account if you inherit it from a spouse. The main difference is that with a Roth IRA, withdrawals from an Inherited IRA or taken as a lump sum are not taxed if the account has been open for at least 5 years. If you take ownership of a Roth IRA, withdrawals of investment gains made before age 59 1/2 are taxed.

If you have any questions regarding an Inherited IRA or any other retirement plan, contact the tax experts at IRA Financial Trust.