If you’re the beneficiary of a traditional individual retirement account, or IRA, the IRS requires that you take minimum distributions from the account at some point – meaning you can’t defer the income tax due on the account’s earnings indefinitely. As a result, placing the distribution payments into a new IRA may not have any tax advantages.
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Traditional IRA Basics
The IRS requires minimum distributions from traditional IRAs because of the tax deferral inherent in this type of account. When the original account owner makes contributions to a traditional IRA, these contributions are tax deductible. This means that instead of paying income tax on the funds at the time the contribution is made, the federal government allows the account owner to defer the income tax payment until withdrawals are made during retirement. However, to ensure that income tax is eventually collected on the contributions and earnings of the investment, the IRS forces the account owner of a traditional IRA to begin taking minimum distributions in the year after reaching the age of 70½.
Surviving Spouse Beneficiary
If you’re the surviving spouse of the original account owner and the sole beneficiary of the traditional IRA, the IRS allows you to treat the IRA as your own. This means that your age, not your spouse’s, is used for determining when you must begin taking minimum distributions. Therefore, if you haven’t reached 70½ years of age, there’s no requirement that you take minimum distributions just because your spouse was required to. Once you reach 70½ years of age, your minimum distribution payments must begin by April 1 of the following year and are reported as gross income on your tax returns. However, there is no restriction on what you can do with each taxable distribution payment. Therefore, if eligible, you are free to place those funds, as well as the remaining account balance not subject to a minimum distribution payment yet, into a different IRA.
For all other traditional IRA beneficiaries, including surviving spouses who don’t treat the IRA as their own, the IRS requires minimum distribution withdrawals to begin in the year after the account owner’s death. Your other option is to liquidate the entire account by the end of the fifth year after the owner’s death – using the year after the death as the first year – and report the entire liquidation payment on your tax return. And just like a surviving spouse, you’re free to put the minimum distribution or taxable liquidating payment into another IRA account. Keep in mind, however, that you can never avoid paying tax on minimum distributions, so placing these payments into another IRA doesn’t reduce the tax you owe on minimum distributions.
When choosing the type of IRA to place your minimum distribution payments in, it’s important to remember that you cannot open a traditional IRA unless you have earned income from employment and are under 70½ years of age. If you can’t satisfy both requirements, your only option is to place the distributions into a Roth IRA.