Inheriting an IRA
Although IRAs are primarily intended to help fund retirement, some people don’t withdraw all IRA assets during their lifetimes. Any remaining assets go to the account owner’s designated beneficiaries and could provide a generous legacy.
If you’ve inherited an IRA or might inherit one in the future, it’s important to understand your options. IRS rules and regulations for inheriting an IRA can be complex, and an uninformed decision could result in unexpected taxes and penalties.
To Stretch or Not to Stretch?
The lump-sum approach may be appropriate for small accounts, but you should think twice before liquidating a large account. Distributions from a traditional IRA are subject to ordinary income tax, so taking a large distribution could push you into a higher tax bracket and reduce the potential value of the inheritance. Roth IRA distributions might not be taxable (as long as the original owner met the Roth five-year holding requirement), but liquidating the account would lose the benefit of potential tax-free growth.
A nonspouse beneficiary who doesn’t cash out should properly retitle the account as an inherited IRA — such as “Joe Smith (deceased) for the benefit of Mary Smith (beneficiary).” Inherited IRAs are not subject to early-withdrawal penalties, but they are subject to annual RMDs, which must begin no later than December 31 of the year after the original owner’s death (regardless of the beneficiary’s age). However, if the original owner died after age 70½ and failed to take an RMD in the year of death, the beneficiary must take at least the amount of the RMD by December 31 of that year.
A surviving spouse who is the sole beneficiary has more options. The survivor can treat the assets as his or her own by rolling them over to an existing or a new IRA. RMDs would not have to start until age 70½ (distributions prior to age 59½ may be subject to a 10% early-withdrawal penalty). If the account remains an inherited IRA with the surviving spouse as sole beneficiary, minimum distributions are based on the beneficiary’s or the late spouse’s life expectancy (whichever is longer). If the late spouse died before reaching age 70½, distributions can be delayed until the year he or she would have turned 70½, but RMDs would be based on the surviving spouse’s life expectancy.
Another option that may be available to both spousal and nonspouse beneficiaries is to disclaim the IRA and allow it to pass directly to the account’s contingent beneficiaries. RMDs typically would be lower if based on the life expectancy of a younger beneficiary, which may result in a greater opportunity for the assets to pursue growth.
RMD rules become more complex when multiple beneficiaries are designated or when the IRA is left to the estate or a trust. Be sure to consult with a tax or estate professional before taking any specific action.
The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. Copyright 2015 Emerald Connect, LLC.