If you inherit an IRA or 401(k) plan you have to be careful to understand the legal & tax implications before you make any moves! If you handle it the wrong way you might be stuck with paying Federal & state income taxes on the entire amount in the plan as a total distribution all in one year.
Many people are surprised to find out that the funds they withdraw from an inherited IRA are subject to income tax, since most inherited assets are not (only subject to estate taxes if it is a large estate). However, since the original owner of the plan never paid income tax on those funds they are passed to the beneficiary with the same "pre-tax" status.
Fortunately, the person who inherits the plan has the option of deferring some or all of the tax until a later time:
Exception to 10% early withdrawal penalty - the funds distributed from a deceased persons IRA are not subject to the early withdrawal penalty regardless of the ages of either the deceased person or the person who inherits the IRA.
Spouse - a spouse who inherits an IRA or 401(k) plan has the option of rolling over into his/her own IRA within 60 days. However, you want to make sure to seek the advice of a tax professional because there can be downsides to this type of rollover since the funds that were rolled over now take on the characteristics of the new owner's IRA. For example if the spouse who inherits a plan is under age 59 1/2 and rolls the funds into his/her own IRA the 10% premature distribution penalty will now apply to any withdrawal of the inherited funds from the IRA.
Non-spouse beneficiaries - for any person other than a spouse who inherits an IRA or 401(k) plan you need to make sure it is a "trustee to trustee" rollover & it has to be rolled over directly into a special plan known as an "inherited IRA". If there is more than one beneficiaries you can have the rollover split directly into separate inherited IRA's. Make sure not to have a check issued to you by the trustee of the original plan if you are intending a rollover!
Required Minimum Distributions (RMD) - depending on the age of the original owner the person who inherits the plan will be required to make distributions from the plan (sometimes beginning immediately). This is another part of the equation that requires a good tax plan so make sure you have competent tax advice so you can optimize the amount & timing of these distributions.
This is a complicated area which has many variables. Charles Schwab has an excellent booklet on the various options and rules involved. This is not an endorsement for their financial services, just an endorsement for their book which is very informative and well written. Most financial institutions should be able to set up an inherited IRA, so you can choose who ever you are comfortable with to set up your new account.
