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December 10, 2011

Inherited IRAs are more complex than many realize.

The rules for Individual Retirement Accounts (IRAs) require careful planning.  The person establishing the account should understand more than how much they can contribute.  Understanding the rules for withdrawals can result in greater benefits for the beneficiaries. 
There are two sets of rules that impact the operation of IRAs.  Legislation authorizing the IRAs have operating rules.  The financial institution that sponsor IRAs have additional operating rules.  Often the impact is on the beneficiaries of the IRAs.  
Naming your estate or a trust that is not a “see-through trust” as beneficiary will reduce the benefits for the beneficiaries.  Sometimes these limitations can be eliminated by transferring the inherited IRA to another financial institution.  To achieve the benefits, this must be done by a direct “trustee to trustee transfer”.
When an inherited IRA is liquidated, it will often reduce the benefits available to the beneficiaries.  If annual withdrawals are taken, the remaining balance is allowed to grow.  the current income and gains in the inherited tax will not be taxed currently.  If the account is liquidated the account will be taxed.  This reduces the amount available for investments.
Withdrawal rules for an inherited IRA are different than those for the original owner of the IRA.  Distribution are generally taken over the life of the beneficiary.  Each year the initial term is reduced by one.  
If the original owner of the IRA was 701/2 or older, they were required to take the required distribution in the year they died.  A beneficiary should make sure that distribution is made by December 31 of that year.
An inherited IRA cannot be rolled into an IRA of the beneficiary.  The title must make it clear that the owner died and you are the beneficiary.     
Different rules apply if the IRA is a Roth IRA.  Beneficiaries are required to withdraw annual minimum amounts.  A 50% penalty applies if the annual minimum distributions are not made.
You should check with your estate planning professional who is familiar with your specific situation when setting up IRAs or taking distribution.

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