What To Do With Inherited IRAs
I inherited an IRA. What do I do now?
Many of our Estate Planning clients have at least one IRA in their financial plan. And those who have lost someone they love are often the beneficiary of an IRA that someone other than their spouse owned. This requires them to make some significant choices that involve many planning and distribution factors. The goal is providing for your current needs while maximizing the value of the assets received.
Paying fewer taxes is often one of the most important factors when deciding how to handle money from an inherited IRA. Distributions from inherited traditional IRAs are taxable. Qualified distributions from an inherited Roth IRA are tax-free. If you are younger than 59 ½, IRA distributions trigger a 10% tax penalty. Big distributions can put you into a higher tax bracket. Smaller distributions over time can avoid that problem. And if you don’t have an immediate need for the assets, minimizing distributions lets more of your money grow tax-free over time.
Inherited IRA Distribution Options
If you are a non-spouse IRA beneficiary, you must take distributions unless you disclaim the IRA inheritance. There are, however, several options for how much you must take. Choosing the right one is important because you can’t put the money back within 60 days since rollovers and contributions are not allowed in these accounts. That also means you can’t roll this money into your own IRA.
- Lump-sum—Taking all the money in one lump sum will empty the entire account all at once. Doing this means the assets will lose their tax-advantaged status. You will owe taxes on the taxable portion in the year you received it. And receiving a lump-sum distribution may put you in a higher tax bracket. Once you choose to take a lump-sum distribution, you can’t undo it.
- Life expectancy—Available for both Roth and traditional IRAs, this option is often called the “stretch-out.” Choosing this option lets you take annual required minimum distributions (RMDs) based on your remaining life expectancy using IRS life-expectancy tables. These RMDs will begin the year following the IRA owner’s death. You can always take more than the RMD. But by taking only the minimum, the remaining money grows tax-free for much longer.
- Five-year rule—This option is available for both Roth and traditional IRAs if the IRA owner died before meeting their required beginning date (RBD). The RBD is generally April 1 following the year the owner turned age 70½. The five-year rule requires you to fully distribute account by December 31 of the year containing the fifth anniversary of the owner’s death. For example, if the owner died in 2018, you would have to distribute all the funds by December 31, 2023. You can, but aren’t required to, take distributions before that date. This can help avoid having to pay taxes on the entire amount in the first year but requires larger distributions over a shorter time.
- Disclaim—If you do not need or want the IRA, you can disclaim it. That means you can refuse all or a portion of the assets. Generally, you must do this within nine months after the IRA owner’s death. If you disclaim the IRA, you can’t dictate who will inherit it. If the owner chose the per stirpes option as part of the beneficiary designation, then the disclaimed assets will go to that your children, grandchildren, etc. If not, then the IRA passes to any other named primary beneficiaries. If there aren’t any of those, the assets go to the designated contingent beneficiary.
If you have retirement assets, you may want to consider a Retirement Plan Trust. The IRS requires retirement assets to be handled differently than other assets in your estate. For that reason, we offer the option for a separate trust designed exclusively for those assets. If you would like more information on retirement plan trusts, click here for a copy of our report “Is Your IRA an IOU to the IRS?”
**A portion of this article was taken from “Inheriting an IRA as a Nonspouse Beneficiary”, by Wells Fargo.
Author: Susan Barnett