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, you do not need to turn your IRA account over to the estate regardless of what the will says or how the executor 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 states that an IRA rollover or an IRA should be left to the estate, the beneficiary designation takes precedence.

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 you want to leave your IRA account to your spouse or your children, you must designate them as beneficiaries. You should also keep your IRA and 401(k) beneficiary list up to date as your family circumstances change.

A will that asks for “cash on hand” to be distributed among family members refers to probate assets of the descendant. “Assets that pass by beneficiary designation are not probate assets, and are, therefore, not subject to the terms of the will,” said Michael Delgass, chief executive officer with Sontag Advisory in New York. “An IRA account is the most common example of this type of asset. These assets have a contractual agreement with the entity holding them (here, the custodian of the IRA) that requires that entity to pay them out to the beneficiary.”

IRAs and 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 cash on hand,” said Adam Harding, a financial advisor in Scottsdale, Arizona.

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 & Company in Suffolk, Virginia.

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.