I inherited a family member's retirement assets. What are my options in managing this money?

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Retirement assets frequently include monies within an employer-sponsored retirement plan such as a 401(k) or 403(b) plan, an IRA, an annuity, or some combination of these accounts.

Employer-sponsored retirement plans

In the case of an employer-sponsored retirement plan, federal law requires that a spouse be the primary beneficiary unless he or she waives that right in writing. When retirement plan assets are left intact within an estate, spousal beneficiaries may inherit the money without paying federal estate or income taxes. After age 70½, the surviving spouse must begin taking required minimum distributions (RMDs) based on his or her life expectancy. The RMDs are taxed as ordinary income. This withdrawal schedule may be preferred to cashing out the entire bequest at once, which may trigger higher tax payments.
With nonspousal beneficiaries, the plan's rules and the timing of the inheritance may determine the beneficiary's options. Some employer plans offer nonspousal beneficiaries the option of completing a trustee-to-trustee transfer from an employer-sponsored plan to an IRA and subsequently taking required minimum distributions (or RMDs) based on the beneficiary's life expectancy. Just like distributions to spousal heirs, distributions taken by nonspousal heirs are taxed as ordinary income.
Before taking any action, it is critical that beneficiaries determine the rules of the deceased's retirement plan and consult a tax advisor who can help beneficiaries review their options and determine what action may be best under their individual circumstances.

IRAs

With an IRA, spousal beneficiaries may designate themselves as the account owner and treat an inherited IRA as their own. This means a surviving spouse can transfer the assets to an existing IRA or to an employer-sponsored plan. These transfers typically do not trigger tax payments as long as a spouse follows the rules for trustee-to-trustee transfers. After age 70½, a spousal beneficiary is mandated to take annual RMDs, which are based on the surviving spouse's life expectancy and are taxed as ordinary income.
Nonspousal beneficiaries cannot transfer assets within an inherited IRA to an existing IRA. Instead, they have two options: They may take all distributions within five years of the original account owner's death or take annual distributions determined by the life expectancy of either the beneficiary or the decedent, whichever is longer.

Annuities

If you receive a survivor annuity, the tax status of periodic payments to you is determined by the cost basis of the deceased. If the deceased had no cost basis (i.e., did not pay anything for the annuity contract), periodic payments to you are taxable. Assuming the deceased had a cost basis, amounts up to the cost of the contract are not taxable, but amounts in excess of the deceased's cost are taxed as ordinary income.
Because determining the tax status of inherited assets can be complicated, you should consult a tax advisor to answer any questions you may have.

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