The rollover into a non-spousal beneficiary's receiving IRA (an IRA set up specifically to receive an inherited retirement plan distribution) must be accomplished via a direct (trustee-to-trustee) transfer that does not pass through the hands of the beneficiary (you).
Inheriting non-spousal retirement funds can be very, very tricky. One mistake and boom! The IRS will descend with a vengeance.
You can’t teach an old dog new tricks, but you can teach an inherited non-spousal IRA to “rollover” correctly. In fact, if you do not handle this basic financial transaction with care, then it will cost you.
As with most tax moves, there is a wrong way and a right way.
First, the wrong way. In former times you had no choice as a “non-spousal” inheritor of an IRA. You had to take the entire account balance as a “lump-sum” and take the tax hit. Similarly today, the result is the same if the money reaches you before it reaches an IRA trustee.
Now, for the right way, as described in a recent article in SmartMoney titled Rolling Over Uncle Henry's 401(k). Essentially, you can let your inherited IRA spill over into a newly created IRA you establish to receive regular distributions from the inherited IRA. Note: the retirement funds you inherit cannot be accumulated tax-deferred in the newly created IRA, as under certain rules that apply to spousal IRA rollovers. In fact, you are required to make minimum withdrawals or face a 50% excise tax on the difference between what you should have withdrawn and what you actually did withdraw.
For further guidance on the rollover “dance steps,” an article in Forbes is spot on. The article, titled IRA Rollovers – Let's Be Careful Out There, even reviews some recent court cases to illustrate the finer points of an entirely trustee-to-trustee rollover. Never let an IRA trustee of an inherited IRA write a check directly to you! Instead, instruct the trustee to talk to the new trustee of your newly created non-spousal beneficiary IRA to coordinate the transfer.
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Reference: SmartMoney (August 9, 2012) “Rolling Over Uncle Henry's 401(k)”
Forbes (August 2, 2012) “IRA Rollovers – Let's Be Careful Out There”