If you’ve recently inherited an IRA, chances are you know that there are some big decisions on the horizon, decisions that can have a financial impact that you are not prepared for; and maybe one that can’t be undone.
And just as important for those among you who have been down this road before, changes have occurred with 2019’s Secure Act which will impact your decisions. The act has insured that inherited IRA accounts are fully spent no later than 10 years after the death of the original account holder (with only a very few, very limited exceptions).
This can impact the way in which you decide what to do with this retirement product, including, possibly, declining to accept it. Here are some basic facts to help insure you know where to go from here, safely.
What is a Traditional IRA?
Of the two types of IRA (Individual Retirement Account) choices, the Traditional IRA is the one whose contributions are often tax-deductible. IRAs incur income taxes when any of the funds are withdrawn (whether they are from original contributions or from their earnings such as interest).
You can withdraw funds at any time, although you must start withdrawing funds by a certain age; this is known as RMD (Required Minimum Distribution). If, however, you withdraw funds before reaching 59.5 years of age, there is almost always an early-withdrawal penalty. RMDs are very different with inherited IRAs.
There are limits in contributions to these accounts, based on your taxable income/compensation. These limits are also affected by other retirement savings products you may have, such as contributions to a Roth IRA, etc.
What is a Roth IRA?
The Roth IRA is a retirement savings account in which your contributions are not tax-deductible, but the funds and any earnings in the account do not incur income taxes (as long as they’re qualified funds: the IRA account is open at least 5 years) when they are withdrawn.
You can also withdraw funds at any time (with some early-withdrawal penalties, as with the traditional IRA). Unlike the traditional version, there are no RMDs to worry about. Except, when you inherit one of these accounts.
If you are inheriting an IRA account, here are some questions that will direct your next decisions.
What is your relationship to the holder of the IRA?
How you decide to handle the IRA from a spouse will depend on your age, income needs and tax situation.
What type of IRA did you inherit?
First, you need to learn which of two types of IRA you have inherited. There are noteworthy differences between them, and suggestions about how to proceed. The differences will not only impact what your monetary outcomes will be, but will also be impacted by certain dates and timelines.
What Deadlines/Timelines Should You Worry About?
- If you’ve inherited either type of IRA, what year will it be that marks 10 years after the death of the original owner of the IRA. Take note of that year; you will have until December 31 that year, to withdraw all the funds from that inheritance.
- If your inherited IRA is from your spouse: you must start making withdrawals from an inherited traditional IRA, no later than April 1 of the year after you have turned 72 years of age.
- If your inherited IRA is from your spouse and you are approaching 72 years of age: determine whether you will follow RMD schedule based on his age at death, or on your current age.
- For the most deferred income taxes, prepare to start withdrawing funds (RMDs) by April of the year after the death, if you are not the spouse.
- If you’ve inherited a Roth IRA, check that the account is at least 5 years old before assuming withdrawals are tax-free.
- If you are intending to use the inherited funds soon, but are not yet 59.5 years of age, consider the 10% penalty tax on those withdrawals.
What about Trusts?
When a Trust has been named the beneficiary, the terms of the Trust will dictate the distribution of any funds from an inherited IRA.
Although the RMD rules and specifications will need to be followed, in terms of transferring funds to the trust, the payouts will then follow what was set out in the Trust.
In addition, unlike an individual receiving inherited IRA assets, the funds within the Trust are not considered assets for the purposes of bankruptcy or qualifying for certain social services.
A see-through trust still requires a schedule of regular distribution of funds, but without limiting the distribution to set timelines the way the IRA sets it out.
Mistakes to Avoid When Inheriting an IRA
The last thing you need when dealing with any new source of income is to discover, too late, that you’ve missed some significant piece of information in managing your inherited IRA.
1. If you are not the spouse, any inherited IRA funds placed into an “Inherited IRA Account” MUST start RMDs the year after the death.
2. When transferring the deceased individuals IRA to an inherited IRA, do not accept a check for the funds; this will nullify your ability to defer taxes on that amount. Be sure to follow the proper inter-account transfer procedure instead. You can request a trustee-to-trustee transfer to insure that no funds are dispersed accidentally through the wrong channels or procedures.
3. Though uncommon, you can decline to take the IRA all together if accepting the IRA and its required income would be financially detrimental to you in the long run.
4. If there is any doubt, then check with a qualified and knowledgeable financial adviser to help you arrive at the best decision for your circumstance.
We can help with Inherited IRA questions
If you find that you have made one of the mistakes listed above there may be ways to undo or mitigate the impact. Managing the complexities of IRA inheritance is much easier with a financial professional by your side. Give us a call today.