Charles Schwab describes inheriting an IRA as a significant financial event with major benefits and significant potential tax liabilities. You must understand your options for an inherited IRA in order to make the most of it. Here at Beck, Lenox & Stolzer Estate Planning and Elder Law; LLC, we have assisted many clients over the years and are now advising family members who are beneficiaries of their IRAs and other assets.
What Is an Inherited IRA?
When someone inherits a deceased person’s retirement account IRA or employer-sponsored retirement account, it creates an Inherited IRA. The beneficiary cannot make additional contributions, but the funds remain tax-deferred with penalty-free withdrawals. However, you must observe certain rules to maintain these benefits and avoid losing the funds. It’s usually necessary to withdraw all funds within 10 years.
What Happens when You Inherit an IRA from a Spouse?
If you inherit an IRA from your spouse, you have the unique option to treat the inherited IRA as your own. This means you can roll over the assets into a new or existing IRA of the same type (e.g., Roth to Roth). This approach can maximize tax-deferred or tax-free growth as you continue making contributions.
What are the Distribution Rules?
The SECURE Act and its recent updates have introduced new rules for required minimum distributions (RMDs). For most beneficiaries, you must fully distribute the inherited IRA within 10 years following the original owner’s death. This rule applies to traditional, SEP, and SIMPLE IRAs, but Roth IRAs only have RMDs after the owner’s death.
For spouses who choose to treat the inherited IRA as their own, the RMD begins after they reach a certain age. This age is currently 73, but will change to 75 in 2033.
Can You Spread Out the Distributions as an Option for an Inherited IRA?
Certain eligible beneficiaries, such as spouses, minors, and disabled individuals, may be able to take distributions over their lifetime. This can help manage tax liabilities and preserve the account’s value for a longer period.
What are Tax Implications of an Inherited IRA?
Inheriting an IRA comes with potential tax implications. Withdrawals from a traditional IRA are generally taxable, while Roth IRA distributions are typically tax-free if the account was open for at least five years. Consulting a tax advisor can help you understand how these rules apply to your specific situation. From there, you can plan the most tax-efficient strategy for taking distributions.
Should You Consider a Lump-Sum Distribution?
All beneficiaries may choose to withdraw the entire account balance at once in a lump sum distribution. While this might be tempting, it could result in a significant tax bill, depending on the account type and size. Spreading out distributions over time can often be a more tax-efficient strategy, preserving more of the account’s value for future use. On the other hand, a lump sum could go toward buying a home or other investments that justify the tax burden.
How to Plan Your Inherited IRA Strategy?
Planning how to handle an inherited IRA involves several steps:
- Identify Your Beneficiary Status: Determine if you are an eligible designated beneficiary or a non-eligible beneficiary to understand your distribution options.
- Consider Your Financial Goals: Consider your long-term financial goals and how the inherited IRA fits into your retirement plan.
- Consult a Professional: Work with an estate planning attorney or a financial advisor to navigate the rules and create a plan that minimizes taxes and maximizes benefits.
Make the Right Choice with Your Inherited IRA
If you have inherited an IRA, our estate planning attorneys are here. Our legal team will offer guidance to help you understand your options and create a plan tailored to your needs. Contact us today to schedule a consultation and start securing your financial future.
Key Takeaways
- Spousal Inheritance Option: Surviving spouses can treat an inherited IRA as their own, allowing for continued tax-deferred or tax-free growth and additional contributions.
- Distribution Flexibility: Eligible beneficiaries can spread out distributions over their lifetime, managing tax liabilities more effectively.
- 10-Year Rule: Non-eligible beneficiaries must fully distribute the inherited IRA within 10 years, requiring careful tax planning.
- Tax Implications: Traditional IRA withdrawals are taxable, while Roth IRA distributions are generally tax-free if the account was held for at least five years.
- Professional Guidance: Consulting with an estate planning attorney or financial advisor can help create a tailored strategy that maximizes benefits and minimizes taxes.
Beck, Lenox and Stolzer has helped many clients understand their windfalls and the tax consequences that may go along with them. If you need help understanding options for an inherited IRA, contact us for a free phone consultation. Click here or call us.
Reference: Charles Schwab (May 1, 2024) “Inheriting an IRA? Understand Your Choices”
