IRA Rollover by Non-spouse IRA Beneficiary is Prohibited

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November 6, 2012

In July 2012, the United States Tax Court reiterated that inherited individual retirement accounts (IRAs) cannot be rolled over. Elizabeth Beech was the beneficiary of her deceased mother s traditional IRA. She received a check from the IRA, opened a new IRA, and deposited the funds from the check into the new IRA. Ms. Beech reported the transfer as a tax-free rollover on her income tax returns. However, because rollovers of inherited IRAs are expressly prohibited by law, the Tax Court found that Ms. Beech was required to pay income tax on the IRA funds.

In general, there are two ways to transfer assets between IRAs – a rollover or a direct transfer. In a rollover, the taxpayer takes control of the assets in an IRA and personally transfers them to another IRA or eligible retirement plan. In a direct transfer, the trustee of an IRA transfers assets from the IRA to another IRA; the beneficiary may initiate the transfer but does not personally take possession of the assets as they are transferred.

The Tax Court’s decision highlights the special care that must be exercised in dealing with the proceeds of an inherited IRA. Your options will depend on whether or not you are the surviving spouse of the deceased IRA owner.

If you are a surviving spouse, you have several options to consider for the tax-free transfer of the assets of an inherited IRA:

  • Status Quo. You may decide to treat the deceased spouse’s IRA as your own IRA.
  • Rollover IRA. You may decide to roll over some or all of the assets of the deceased spouse’s IRA into a rollover IRA. You will receive a distribution of assets from the IRA. Within a 60-day rollover period, you may use any cash distributed from the IRA for personal needs. In order to avoid paying tax on the distribution, you must deposit the distribution into a rollover IRA within 60 days of the distribution.
  • Eligible Retirement Plan Rollover. You may decide to roll over some or all of the assets of the deceased spouse’s IRA into a new eligible retirement plan. The law allows you to choose among qualified individual retirement annuities, trusts, annuity plans, and annuity contracts. You may also choose to roll over the assets into a deferred compensation plan maintained by a state or local government or tax-exempt organization, if applicable.
  • Direct Transfer. You may decide to directly transfer some or all of the assets of the deceased spouse’s IRA into another IRA. You will not receive a physical distribution of assets from the IRA. Rather, you will direct the trustee of the IRA to transfer assets from the IRA directly to the trustee of another IRA. Unlike a rollover IRA, you will not have control or use of the assets for a 60-day rollover period.

If you are not a surviving spouse, like Ms. Beech, the only way to transfer the assets of an inherited IRA free of income tax is by direct transfer. The trustee of the inherited IRA must transfer the assets directly from the inherited IRA to the trustee of another IRA or qualified individual retirement annuity. You must take care not to receive a distribution directly from the inherited IRA, as Ms. Beech did, because you will avoid income tax only if you never gain control or use of the assets in the course of the transfer.

If you have questions regarding the above, please contact Shanna Yonke, the author of this article, or any of the attorneys in the Trusts & Estates Practice Group of Ruder Ware.

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This document provides information of a general nature regarding legislative or other legal developments, and is based on the state of the law at the time of the original publication of this article. None of the information contained herein is intended as legal advice or opinion relative to specific matters, facts, situations, or issues, and additional facts and information or future developments may affect the subjects addressed. You should not act upon the information in this document without discussing your specific situation with legal counsel.

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