It’s best when opening an IRA that you designate one or more beneficiaries. When you pass away, your IRA will then go to your beneficiary without having to go through probate. There are two ways that your plan can pass on to your beneficiary: inheriting it or assuming it. The difference depends on who your beneficiary is.
Let’s look at the difference between the two. When an heir inherits an IRA, he or she receives the assets in the plan when someone else dies. The decedent must have named you in writing as a beneficiary. The original IRA owner may have names more than one beneficiary so you may have to share the assets with others. If an heir assumes an IRA, he or she transfers the assets into his or her sole name. Thus, the IRA will be treated as if it had always belonged to you.
Only a spousal heir has the option of assuming an IRA and even they don’t always have that option. The option is only available if he or she is the sole beneficiary. Therefore, if the IRA is split among heirs, even the spouse does not have the option of assuming the IRA.
If allowed to assume the plan, you will convert the assets into an IRA in your own name. If you already have an IRA, you can transfer the assets directly into it. If not, you may open up a new IRA. Now that that the IRA is only in your name, you can contribute to it just as you would any IRA plan. The major advantage is that you don’t need to start taking distributions until you reach age 70 1/2.
If you inherit the IRA, you may not title it under your name. It must be titled as belonging to the decedent with you as a beneficiary. You may not contribute to an inherited IRA and you cannot roll it over into a new IRA. Further, you must take distributions based on your life expectancy or that of the decedent’s, as determined by the IRS.
Finally, if the inherited IRA is the Roth option, you have the option of taking out the money as a lump sum, taking the entire distribution within five years of the original owner’s death or take distributions based on your life expectancy. We’ll go deeper into this subject at a later date.