Don’t sign, redeem, or transfer anything until you’ve spoken with a qualified counselor, knowledgeable family member, or friend. Advisors report that inherited IRA recipients too often cash their IRA early, losing out on tax benefits that could have been granted to them if they’d just waited a little longer to think about it carefully. The tax benefits disappear forever as soon as you pay out cash from an inherited IRA, with the payout amount classed as taxable income. While the stretch provision is no longer valid for the majority of adult children, it’s important to distribute this inherited IRA in the most tax-efficient way, based on your
individual circumstances.
Note that the rules above apply to both traditional IRAs and Roth IRAs inherited from a spouse. A Roth IRA that you set up yourself is exempt from the RMD requirements during your lifetime, but Roth IRAs received as an inheritance must be distributed using either the 10-year rule or the life support method described above. The IRS offers more rules for your options, including what you can do with a Roth IRA, although the rules differ significantly from traditional IRAs. One of the less obvious benefits of the Roth IRA is that it removes some tax issues when it comes to estate planning
.
If you don’t use up an IRA that is subject to the 10-year rule, any funds remaining at the end of the mandatory distribution period are subject to a 50% tax penalty. Inherited IRAs include transferring assets from parents to spouses, siblings, charities, foundations, etc. Some experts advise IRA beneficiaries not to do anything until they’ve met with a financial advisor who can explain their options. For large accounts, that can result in a monstrous income tax bill, unless the IRA is a Roth. In this case, taxes were paid before money went into the account
.
For example, if you are the sole beneficiary as a surviving spouse and treat the IRA as your own, you may need to take RMDs, depending on your age, or you may need to withdraw the money in full within 10 years. Any type of IRA can be converted to an inherited IRA, including traditional IRAs and Roth IRAs, SEP IRAs, and Simple IRAs. When you take ownership of an IRA that you inherit, you can assign one or more beneficiaries to the account. An inherited IRA is an individual retirement account that is opened when you inherit a tax-advantaged retirement plan (including an IRA or a retirement plan such as 401 (k)) after the owner dies.
If you inherit an IRA from your parents, make sure you understand these rules so you don’t pay more of your inheritance to Uncle Sam than you have to. The trust must be written by a lawyer “who has experience with the rules under which IRAs are left to trusts,” says Choate. Onge, a registered agent with Total Financial Planning, LLC in the Detroit area, talks about IRAs inherited from a spouse. If you’re a surviving spouse, you can transfer the inherited IRA to your own account, but no one else gets that
privilege.
You are subject to the 10-year rule if your parent, grandparent, or anyone else who is not your spouse leaves you an IRA, unless you fall under one of the exemptions listed above. And at the end of the tenth year, the entire IRA balance would have to be distributed and included in taxable income for 2030
.