Tax Rules For Inherited IRAs
Tax laws surrounding inherited IRAs can be intricate, and without due care you could end up paying more in taxes than necessary.
Spouse beneficiaries often benefit most from rolling over assets into an identical account, while non-spouse beneficiaries have two options for taking withdrawals: using either life expectancy or following the 10-year rule.
Taxes
Inheriting an IRA can be complex. There may be various tax ramifications and depending on your relationship or age at death of the account holder, various options could become available to you. Before making your decisions alone, consult a financial professional before making your decisions.
If you are the surviving spouse of the original account owner, you have an option for treating their account as your own and taking required minimum distributions (RMDs) over either your lifetime or that of their remaining life expectancy. This approach could extend tax-deferred growth in investment accounts.
Nonspouse beneficiaries must empty their inherited IRA within 10 years, but you have the option of stretching the withdrawals out over your lifetime and avoiding being hit with a 10% penalty. This strategy, known as the “stretch” strategy, may prove beneficial if your goal is using other sources of retirement income to cover gaps between ages 67 and 70 when Social Security payments start decreasing or pension payouts start being reduced.
Withdrawals
Beneficiaries who inherit an IRA may want to withdraw funds immediately, however this would increase taxable income and negate the tax-deferred growth potential of such accounts. Withdrawal rules vary depending on who owned it (spouse or non-spouse), traditional or Roth, so beneficiaries should consult a fiduciary financial professional for more details regarding their options.
If the beneficiary of a traditional IRA is non-married and not their spouse, required minimum distributions (RMDs) may be taken either over their lifetime or the life expectancy of their deceased spouse. They can also choose to spread them out over 10 years for maximum tax savings and reduced income tax liabilities. Choosing an RMD strategy depends on factors like age, expected retirement date, current tax rate and any potential creditor protection issues that might come up.
Rollovers
IRAs that have been left to you as an inheritance can be subject to complex tax rules, so it’s advisable to consult a financial professional when managing them. Beneficiaries could have different options depending on whether they are the spouse of the account holder or non-spouse beneficiaries.
Spouses typically have the most choices available to them when inheriting an IRA, such as merging it into their own traditional IRA and stretching withdrawals over their lifetime if desired. However, this might not always be best and can have significant ramifications on retirement income.
Non-spouse beneficiaries with an inherited IRA also have options available to them, including using either the five or ten-year withdrawal method or life expectancy withdrawal method to withdraw funds over time and avoid taxes and penalties altogether. It is wise to consult with a financial professional regarding any specifics regarding your situation as the rules can change overtime.
Trusts and Estates
Trusts may also use Individual Retirement Accounts (IRAs). An inherited IRA must be transferred within one year after its original owner passes away to another account that offers traditional or Roth tax treatment – it’s up to them! Non-spouse beneficiaries must begin taking RMDs within 10 years after his/her death and may need to withdraw all assets by age 70 1/2.
Survivors of an IRA owner can treat it as their own and roll it over into an IRA in their name, with distributions staggered according to life expectancy.
An expert advisor on IRAs can be invaluable when making the right choice for your situation, and Bankrate’s AdvisorMatch service makes this easy to connect with one.
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