Inherited an IRA? Here Are the 3 Most Important Things You Need to Know, According to Suze Orman

Don’t make these mistakes if you have inherited an IRA.

Inheriting an IRA is an honor, and with that honor comes responsibility. Someone has trusted you enough to give you some of their hard-earned money. But what options do you have if you inherit an IRA? Every week, financial expert Suze Orman answers financial questions like these from her audience on her popular Women & Money podcast. If you inherit a traditional IRA, should you keep that money separate from your own or should you combine it with your own accounts?

Here are the three most important things you need to know, according to Suze Orman.

Options for an inherited IRA

If you pass away while you have an individual retirement account (IRA), your beneficiary will inherit it. This is known as an inherited IRA or beneficiary IRA. Inherited IRAs can come from a Roth IRA, Simple IRA, or SEP IRA, as well as a 401(k) type plan. The assets in the inherited IRA will continue to grow tax-free, but the withdrawals will be taxed. If you inherit an IRA, say from a spouse who has passed away, you have three options according to Orman.

1. Do nothing

The first option is to do nothing and leave everything as it is. You will continue to remain as the beneficiary of the IRA and not the owner of the IRA. Why would you do this? The required minimum distributions (RMDs) are based on the age of your deceased spouse.

RMDs are minimum amounts that a retirement plan account owner must withdraw every year, starting with the year that he or she reaches age 72. The purpose of RMDs are so people don't just accumulate money in their retirement accounts, not pay taxes, and leave retirement funds as an inheritance.

So if your deceased spouse was younger than you, then you may benefit by doing nothing since the funds can continue to accumulate tax-free and you don't have to take any distributions. For example, if your spouse was 65 and you are 72, the RMDs wouldn't have to be taken out for another seven years. However, if you transfer it to your account, then you would have to start taking RMDs immediately, since you are 72.

2. Become the owner of the inherited IRA

Your second choice, per Orman, is to treat the inherited IRA as your own by designating yourself as the account owner. Why should you do this? If you are younger than your spouse and don't need the money right away, then you don't need to take the RMDs until you hit 72.

For example, if you are 65 and your deceased spouse was 72, then as a beneficiary, you would have to take RMDs immediately, since they are based on your spouse's age and life expectancy. If you instead become the owner of the account, then you don't need to take RMDs for another seven years. Orman states that only spouses have this option.

Why would you not want to do this? Orman states that if you are under age 59.5 and need the money, then you won't pay the 10% early withdrawal penalty if you are not the owner. Orman states that it is important to understand the difference so you don't make a costly mistake.

3. Transfer the inherited IRA into your own IRA

The third option, according to Orman, is to roll over the inherited IRA into your existing IRA. Orman states that this is the best move if you are over age 59.5 and have an IRA in your name and you want everything in one place. It may be more convenient for you to manage if it is in one account. Orman states that this option is not for you if you are under age 59.5. You will have to pay both ordinary income taxes and a 10% early withdrawal penalty if you need to access this money.

When asked which one Orman prefers, she answered that it depends on the age of the person and the age of the spouse who died. Do they need income? By understanding the differences between the three options and your unique circumstances, then you can choose the one that is right for you.

If a trust is the beneficiary of an inherited IRA

When she was asked if there's any difference in the mandatory withdrawal rules if a trust was the beneficiary, Orman stated that in many cases, a trust has five years to withdraw everything. But a trust can have 10 years to withdraw if it is set up correctly. It has to be what's known as a "see-through trust" or a "look-through trust." She recommends working with an estate lawyer to ensure the trust is set up exactly the right way so it can go on for 10 years rather than just five years.

If you want to donate an inherited IRA to charity

Orman was then asked if an inherited IRA can be donated to charity to avoid taxes and if it will qualify as an RMD. Orman states that you can set up a qualified charitable distribution (known as a QCD). You have to be at least 70.5 years of age and give up to a maximum of $100,000 a year as a charitable deduction. She further elaborated that it will then qualify as an RMD.

According to Orman, understanding what you are allowed to do with an inherited IRA and the regulations around them will help you make smarter decisions for you and your family. It can ensure your hard-earned money lasts longer and help you avoid costly mistakes.