“Inherited IRAs and 401(k)s can be a great vehicle for passing assets from these accounts to non-spousal beneficiaries.”
Inherited individual retirement accounts have been a common way to let non-spousal beneficiaries inherit an IRA account and allow the account to continue to grow on a tax-deferred basis in the future. These rules were changed in 2007 to allow non-spousal beneficiaries of 401(k) and similar defined contribution retirement plans to treat these accounts the same way.
Investopedia’s article, “Inherited IRA and 401(k) Rules Explained,” says spousal beneficiaries of an IRA have the option of taking the account and managing it, as if it was their own. This includes the calculation of required minimum distributions (RMDs). For non-spousal beneficiaries, an inherited IRA account can give them a few options, including the ability to stretch the IRA over time by letting it continue to grow tax-deferred.
IRA account holders who want to leave their accounts to non-spousal beneficiaries should enlist the help of an estate planning attorney who understands the complex rules surrounding these accounts. The account beneficiaries must be careful to ensure they don’t inadvertently trigger a taxable event.
The beneficiaries of an inherited IRA can open an inherited IRA account, taking a distribution (which will be taxable), or disclaiming all or part of the inheritance (causing the funds to pass to other eligible beneficiaries). Traditional IRAs, Roth IRAs, and SEP IRAs can be left to non-spousal beneficiaries in this way. A 2015 rule change says the creditor protection previously afforded an inherited IRA was ruled void by the U.S. Supreme Court. Inherited IRA accounts can’t be commingled with your other IRA accounts, but the beneficiary can name their own beneficiaries upon their death.
These rules are complicated, so work with an estate planning attorney to be certain they’re followed to avoid costly errors.
Reference: Investopedia (December 18, 2017) “Inherited IRA and 401(k) Rules Explained”