Inheriting an investment can be an emotional and confusing event. There are many rules that impact a beneficiary’s options when inheriting assets or investments. Making uninformed or hasty decisions can lead to big tax implications and/or penalties.
In this article, we will focus on what happens if a parent passes away and their son or daughter inherits their parent’s IRA. Note that options for a surviving spouse are slightly different and will be covered in a separate article.
If you find yourself inheriting an IRA from your mother or father, here are some things to consider.First, these funds haven’t been taxed yet. Any distributions that you take from the inherited funds will be taxed as ordinary income in the year in which you took the distribution. Also note that there isn’t a 10% early withdrawal penalty on withdrawal after inheriting an IRA from your parents.
You have two options when inheriting an IRA. First, you can distribute the entire account within 5 years of your parent’s death. This option may allow you to defer being taxed on any distributions for a period of time, however needing to fully liquate the balance within 5 years can lead to sizable distributions towards the end of 5 years which could lead to hefty taxes.
Alternatively, you can elect to roll the funds into an inherited IRA. In doing so, the balance rolls over without any tax liability. You will need to make annual distributions from the inherited IRA beginning the year after your parent’s death, however the payments are based on your life expectancy. The younger you are, the lower the annual required minimum distribution from the account.You can take more than the required minimum distribution, but keep in mind that you will owe taxes on the amount you withdraw. When you roll the funds into an inherited IRA, you can continue to manage the investments either on your own or with the help of a financial advisor.
We are often asked if you can consolidate the funds into your own retirement savings that you have.This is not an option. Inherited IRAs need to stay separate from your other retirement savings.
Note that if you inherit a Roth IRA, you have the same option of rolling the funds into an inherited Roth IRA and stretching distributions out over your life expectancy, however the tax treatment of those distributions may be different. As long as the original account owner opened the Roth IRA more than 5 years prior to their death, any distributions from an inherited Roth IRA are tax-free under current tax law.
If you inherit an IRA or other investments, don’t make hasty decisions. Consult our office so that we can help guide you through your options, explain the possible tax implications and incorporate the inherited asset into your own planning.
Reed Financial Planning Services, LLC is here to help you and your family with your planning needs. Reach out to us today if we can be of any assistance to you.
Neither Voya Financial Advisors nor its representatives offer tax or legal advice. Please consult with your tax and legal advisors regarding your individual situation.