An IRA was left to my wife by her father who recently passed away. He was one month short of 59 1/2. What are our
options for the money. Do we report it as income and pay taxes at our tax rate (hopefully not)? Can we just leave it in the IRA? Do we need to change the name on the IRA if we leave it alone?

If your wife is the named beneficiary, she can take distributions over her actuarial life expectancy. If her dad died in 2001, the first distribution has to be before 12/31/2002. It will be taxed as withdrawn. Your wife CANNOT change the account into her name, but her name should be added to the account, as beneficiary. e.g. John Jones, IRA, dec'd; Mary Smith, beneficiary.

The bank explanation was that the IRA would be in my wife's name but would still show her father on the account as dec'd. Therefore it could not be combined with her IRA but would still have the same rules as her IRA. Therefore any money taken out would have a penalty applied (until she turns 59 1/2). So the equal distribution over her life expectancy applies after she is 59 1/2. Is this correct?

IRS publication 590 might help (requires Adobe Acrobat).
http://ftp.fedworld.gov/pub/irs-pdf/p590.pdf

The payments over her life expectancy must start in the year after the year of death, regardless of your wife's age. There is NO, repeat, NO, 10% penalty for withdrawals on account of death. The person in the bank gave you wrong info.

An inherited account does not have the same rules as your own IRA account.

.......and only the spouse has special rights when inheriting an IRA.

Pax, be careful, this was a father leaving to a daughter, not a husband leaving to a wife.

Barry, Is it correct to say the "over the lifetime" would be true even if a ten year old child was the beneficiary? I think the "wife" part is just confusing this story.

You have to wonder about these bank employees who just are not trained on the rules! All those books on "excellance" and the importance of training clearly collect more dust than readers.

John,

Under the new rules, a designated beneficiary takes distributions over his or her lifetime. The tables go down to age 5.

Barry