Inheriting an IRA

An IRA, Individual Retirement Account, is a personal retirement account. Contributions to IRAs are either pre-tax (traditional IRA) or after-tax (Roth IRA).
If a someone passes away before his IRA is depleted, his heirs may inherit the IRA. Here are a few frequently-asked questions about the consequences of inheriting an IRA.

Q: What should I do? Should I cash out the IRA?
You're legally allowed to withdraw that money, but doing so is generally not recommended, because you'll lose the IRA's tax benefits.
If you decide to make withdrawals (which are known as "distributions"), it's generally best not to do so in one giant lump sum. If you've inherited a Traditional IRA, you'll be hit with a huge tax bill when you make that withdrawal.

Q: How Can I Maximize the Tax Benefit?
Delay making withdrawals from the IRA for as long as legally possible. The longer the money stays in the account, the longer it can grow tax-free or tax-deferred.
At a certain point, you'll be legally required to begin withdrawing money from the IRA. (The rules regarding the length of time before you're legally mandated to withdraw money from the IRA are extremely complicated. Seek the advice of a legal and tax professional.)
When that happens, take the smallest possible distribution that you're legally allowed to take. Why? Because IRA's are tax-advantaged. The longer you leave money in it, the more time that money can grow.

Q: Can I Put the IRA Into My Own Name?
If You Are the Spouse of the Deceased: Yes. You can name yourself the account owner or you can combine it with your own pre-existing IRA. You can contribute new money to the IRA.
If You Are NOT the Spouse of the Deceased: No. You can, however, set up a "beneficiary IRA" that carries both your name and the name of the deceased.
If your name is John Doe, for instance, and the name of the deceased is Jane Smith, you can set up a beneficiary IRA called: "Jane Smith, Deceased 01/01/1980, F/B/O John Doe." This signals that you're the named heir and beneficiary to the IRA.

Q: Do I Have to Pay Taxes?
If it's a traditional IRA, yes, you have to pay taxes on all the money that you withdraw. (This is true regardless of whether its an inherited IRA or your own personal Trad IRA.)
If it's a Roth IRA, then no - you can withdraw money tax-free. (Just bear in mind that you'll lose the compounding tax advantage when you withdraw that money).

Q: Can I Make Additional Contributions to the IRA?
If you're the spouse of the deceased, yes. If you're not the spouse, no. Of course, you can always set up your own IRA if you're eligible to do so.

Q: When Will I Be Legally Required to Withdraw Money from the IRA?
If you're the spouse of the deceased, and you take over as the account owner by either naming yourself on the IRA or merging the account with your own IRA (see above), all the normal rules governing IRA distributions remain in effect. The fact that it's inherited will have no bearing.
If you're not the spouse, and the person from whom you inherited the IRA was already taking mandatory distributions, and that person didn't take a distribution during the calendar year in which he/she died, then you must take a distribution by Dec. 31 of that year.
If you're not the spouse and the person from whom you inherited the IRA took a mandatory distribution in the year in which he/she died, you'll have to take a distribution by Dec. 31 of the following year.
Every year thereafter, the amount you're legally mandated to take out is dictated by the IRS, based on either your own life expectancy or the non-readjusted life expectancy of the deceased (the life expectancy that the deceased would have, if he/she hadn't passed away). These formulas and rules are extremely complicated. Always consult a tax professional, legal professional and licensed financial professional before making any financial decisions.