Hello, Estate Planning. Here Is Your IndustryNewsletters Estate Planning Marketing Brief for Tuesday, October 22, 2019.
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Inheriting an IRA: How to Handle It

 

What are the tax implications of an inherited traditional IRA? Tax rules differ depending on whether or not the beneficiary is a spouse. Be sure you know the rules, because your decisions may have serious tax consequences.

If you're a spouse of the deceased, you have a number of scenarios, depending on your age. One available option in many cases is for the surviving spouse to just roll it over into his or her own IRA or a new one.

But there are different rules if someone else, like a child, inherits a traditional IRA. In that case, your two potential choices are:

  • Sell the assets and take a lump sum withdrawal. You will have to pay tax as if it were ordinary income. Based on your bracket, that could mean the government gets a big slice of the pie.
  • Keep the account invested in a new "inherited IRA" account. It will continue to grow tax-free, but you have to make minimum withdrawals. You may make these withdrawals regularly based on your life expectancy, or up to five years after the inheritance, at which time you must withdraw the entire sum.

Basically, there's no way to avoid the tax. All you can do is postpone it. Either way, however, there is no withdrawal penalty.

Different Rules for Roth IRAs

With a Roth IRA, the money went into the account after taxes, so the scenarios are somewhat different. When spouses inherit, they again have the option of rolling it over into their own new IRA. Also, they can take a lump-sum distribution, but they should keep an eye on the calendar; the earnings will be taxable if the account is less than five years old.

Those who are not spouses have a better deal with a Roth than with a traditional IRA. A lump sum is still an option, although there will be taxes on earnings if the five-year mark hasn't been hit. They can also use the life expectancy method — distributions come out tax-free (if the five-year holding period has been met); otherwise, only earnings are taxable.

These are just the basics, and there may be other options, or situations that impact your choices. There are also modifications to these rules if an IRA has been left to be divided among multiple heirs. The key takeaway here is to not make any immediate decisions after inheriting an IRA but to consult with a financial professional about what the best move is in your situation.

Making the Future Easier

As for any IRAs you have now, you can make life easier for your own heirs by updating any beneficiary designations. It's a common misconception that a will can override any IRA designations. It doesn't. This causes problems when the beneficiary is deceased, or worse, the IRA is left to an ex-spouse instead of the current spouse.

Also, choose beneficiaries with care. For example, it might not be the best choice to leave an IRA to someone in a high-income bracket who will have to pay a lot to take out the money. Again, consult with a financial professional.

 


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Estate Planning Marketing Brief
Robert Slavitt
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