Here's how to make sure it's clients-not the IRS-who get IRA windfalls.

Death and taxes cannot be avoided, but a big tax bill on inherited IRAs can. Of all the assets clients may inherit or leave to heirs, IRAs provide a unique benefit: the opportunity to continuing tax deferred investing. Over time, the tax advantage can dramatically increase the value of the inheritance-often for clients and their heirs.

That's the good news. The bad news is that the IRS rules for making the most of the tax advantages that come with inherited IRAs-finalized last summer-run about 45 pages long and are as dense with caveats as the Black Forest.

Ensuring clients know that real benefits can be had or lost with inherited IRAs and helping with decisions about them should be an integral part of your practice and client communications.

For one, clients need to know that cashing out an inherited IRA can be costly. The cost of taking a lump-sum distribution on an inherited IRA with a market value of $150,000, for instance, can cost beneficiaries between $37,000 and $58,000 in state and federal income taxes, depending on their tax bracket.

"What we do upfront is examine the client's needs and discuss what they're trying to accomplish. Then we'll present them with the most advantageous options," says Donna Miller, president of MillerMusmar, a planning and accounting firm with offices in Reston and Manassa, Va.

Three variables affect a beneficiary's choices:

1. From whom did the investor inherit the IRA?

2. How old was the IRA owner when he or she died?

3. What is the timeline the recipient has for making choices regarding transfer options?

Options For Spouses

There are three options when a spouse inherits an IRA. First, they can roll the inherited IRA into their own new or existing IRA and base both the timing and amount of minimum required distributions (MRDs) on the IRS' Uniform Lifetime Table. This assumes distributions extend over two lives-the inheritor's and a beneficiary who is 10 years younger than the inheritor. That has tremendous advantages for a spouse who hasn't reached 70 1/2 yet, but whose partner had, because it allows the recipient to wait until he or she is 70 1/2 before beginning MRDs. That means the timing of MRDs and the yearly withdrawal amount will be based on the surviving spouse's life (as interpreted in the IRS' Uniform Life Expectancy Table).

"If the spouse is younger than 70 1/2, they're also eligible to make annual contributions to the IRA, which increases the power of tax deferral and compounding," Miller says.

There is, however, a downside to spousal rollovers. If the inheriting spouse is not yet 59 1/2 but needs cash from the IRA, he or she will be subject to the 10% early withdrawal penalty. One exception, which provides an end-run around the 10% penalty, allows recipients to take substantially equal periodic payments, which can be stopped without penalty after five years or when the inheritor turns 59 1/2, whichever comes later.

A second withdrawal option is for a surviving spouse to transfer inherited IRA assets to a beneficiary distribution account (BDA). While the timing of the distributions will be based on the deceased spouse's age, the amount of MRDs will be based on the inheriting spouse's age and calculated each year based on factors in the IRS's Single Life Expectancy table.

If the inheriting spouse is older than 70 1/2 and the deceased spouse died before age 70 1/2, this option allows the inheriting spouse to postpone taking MRDs until the year the deceased spouse would have turned 70 1/2. That means more tax deferral and savings.

If the inheriting spouse is younger than 59 1/2 and needs to tap funds in the IRA, creating a beneficiary distribution account (BDA) will allow him or her to do so without incurring a 10% early withdrawal penalty. The inheritor also could take equal periodic payments using his or her life expectancy and that of a chosen beneficiary. But this option might require withdrawing more funds and paying more taxes than might be necessary to meet their capital needs.

One worthwhile note here, according to Miller: If a spouse was 70 1/2 or older and was still owed a MRD the year he or she died, the spouse-beneficiary must take that distribution based on the deceased spouse's schedule by December 31 of the year the IRA owner died. In addition, the funds must be distributed under the beneficiary's tax identification number.

When it comes to estate planning, whether your client transfers the money to his own IRA or a BDA, he will still be considered the owner of the IRA and can now direct how the funds are inherited by naming new primary and contingent beneficiaries. Another estate planning tactic worth mentioning: A spouse who doesn't need the assets can disclaim all or part of an inherited IRA, which will allow the proceeds to pass to the next generation of eligible beneficiaries. Children or even grandchildren can take MRDs based on their life expectancies, which would stretch the life of the IRA out for years or even decades.

Based on the IRS' Single Life Expectancy Table, a 30-year-old would be required to take an MRD of just $1,904 on an inherited IRA with a market value $100,000, or just $9,578 of a $500,000 IRA. By disclaiming an IRA's assets, the inheritor will have stretched out the IRA's tax-deferred benefits for the lifetime of their own heirs and possibly their heirs' heirs. But the IRA custodian must be willing. If it isn't, more advisors are recommending that clients change custodians and rename primary and contingent beneficiaries.

If your client chooses to disclaim the inherited IRA, he or she must do so within nine months of the IRA owner's death and before they've taken possession of the IRA assets.

Options For Others

Clients who inherit IRA assets from someone other than their spouse can still keep IRA inheritances growing tax-deferred by utilizing one of two options.

The first option is to create a BDA. This gives clients the ability to control how assets are invested and who will inherit the assets when they die. There is no way to delay minimum required distributions, however. MRDs must begin by December 31 of the year following the IRA owner's death and will generally be based on the spouse's life expectancy.

Another option for clients who don't need the assets from an IRA inherited from a nonspouse: Disclaim all or part of the inheritance within nine months of the IRA owner's death. The disclaimed assets would then pass to the next eligible beneficiaries.

Considerations For Advisors

While Roth IRAs are delightful, tax-free retirement accounts for the Roth owner, they can be less beneficial from a tax-deferred perspective for the inheritor simply because the IRS is determined to see that the money is distributed and is not passed on to more than one set of beneficiaries tax-free. As a result, both spouses and others who inherit a Roth and transfer the funds to a BDA must begin taking minimum required distributions by December 31 of the year following the IRA owner's death. The good news for those inheritors who are younger than 59 1/2 and want to tap some of the funds-they can be withdrawn tax-free forever, provided the assets had been in the account for five years or more.

Deadlines are also a crucial element when it comes to assisting clients who have inherited IRAs. Usually the deadline for beginning MRDs from an inherited IRA beneficiary distribution account is December 31 of the year following the IRA owner's death. If a client misses that deadline and the deceased IRA owner had not yet reached age 70 1/2, the client will pay an additional 50% tax on missed MRDs. Is there any way to get out from under the 50% tax? Thankfully, the answer is yes for both spouses and others who inherit IRAs. "You can ensure that the MRD penalties are waived if you take advantage of the IRS's five-year rule," says Miller.

To use the five-year rule, clients must withdraw all assets from the inherited IRA by December 31 of the fifth year following the IRA owner's death. The five-year rule also allows inheritors to withdraw any assets they want from the IRA at any time in any amount as long as it's depleted within the five-year timeframe.

This five-year schedule might work well for clients who aren't 59 1/2 and want to accelerate distributions. But keep the deadline for taking minimum required distributions in mind for everyone else. A five-year distribution schedule will be a tax and estate planning nightmare for those who want to stretch out the life of their IRA for the benefit of heirs.