If you’ve been named a beneficiary or inherited an IRA, you’re likely facing wondering what are the next steps and what happens now? As the beneficiary of a loved one’s retirement account, IRS rules will determine the amount you owe in taxes as well as whether you will need to begin taking required minimum distributions. This will be based on your relationship to the deceased and whether the IRA you've inherited is a Roth IRA or traditional IRA.
When someone you love passes away, thinking about the tax law is probably the last thing on your mind. However, upon discovering that you are the beneficiary of a retirement account, you will need to make decisions about how to properly handle the finances of the assets you are inheriting, so that you are not inadvertently left with a staggering tax bill.
Making informed and well-educated decisions can help you successfully achieve your financial goals. Alternatively, making inaccurate choices may cost you a portion of your inheritance in taxes or IRS penalties.1 Thus, in your circumstance, it is critical to understand the rules surrounding an inherited IRA.
Those who inherit IRAs often have questions pertaining to how and when they’re able to withdraw money from the account involved. IRS rules regarding distributions take into account a number of factors, including:
A factor that influences required minimum distribution (RMD) payments, potential penalties and other details of inherited IRAs is age. For instance, if the account holder died before or after the age of 70½ (at which time the IRS requires you to take minimum withdrawals from a traditional IRA) there are implications involved for beneficiaries of inherited IRAs. The age of 59½ is also important, especially for surviving spouses who decide to transfer the account balance into their own IRA accounts and subsequently withdraw the funds.2
Whether you inherit a traditional or Roth IRA is another deciding factor that influences distribution details. With an inherited IRA, you are required to take distributions either within your lifetime or within five years following the passing of the original account holder.3 If you inherit a Roth IRA, you don’t pay taxes on distributions, but if you inherit a traditional IRA, you’ll generally pay taxes on the distributions you take in excess of the deceased account holder’s basis. This will depend on whether the deceased’s contributions were deductible or non-deductible.
When a Spouse Inherits
If you are the surviving spouse you will be faced with three options when inheriting an IRA:
The first option is to remove the money from the account and spend or invest it as you see fit. Depending on the size of the account, inherits going this route may possibly incur a tremendous amount of taxes.
Alternatively, you may consider remaining the beneficiary of the existing IRA or transferring the assets to a retirement account under your name. Because it’s a simpler option, many people choose to move the inherited amount into an IRA in their own name. If you’re interested in combining these assets with an existing retirement account, you may have the funds transferred. It is important to note that if you transfer any distributed money to a new account in your name, you must do so within 60 days. This will allow you to avoid taxation on any withdrawals, allowing the amount to continue to grow tax-deferred.4
It may also make sense to leave the inherited money in the original account and use the funds as needed as a beneficiary. For example, when you are under 59½ years old and transfer the inherited IRA to your own retirement account, you will not be able to access the money without a penalty. Until you reach 59½, the withdrawals will be taxable and will also incur an additional 10% IRS penalty.5
When a Non-Spouse Inherits
When you are inheriting an IRA from someone other than your spouse, the details become more complicated. Unlike an IRA that is inherited from a spouse, you will not be able to move this money into your own retirement account. In order to keep the tax benefits of the account, you will need to set up a new Inherited IRA for Benefit of your name.6 Once the account is created, you may transfer assets from the original account to your beneficiary IRA. While this may seem confusing, a trusted financial advisor can guide you through the process.
It is also important to note that you will not be able to make new contributions to an Inherited IRA. Regardless of your age, you will need to begin taking required minimum distribution payments from the new account by December 31st of the year following the original owner’s death.
Whether you’re a non-spouse inheriting an IRA (as an individual or if it is left to multiple people) or a spouse who is not the sole beneficiary, there are a few key details to keep in mind. In any of these instances, the IRS does not allow you to transfer the money from an inherited IRA into an existing account of yours. Instead, you will have to transfer your portion of the assets into a new IRA that is set up and formally named as an inherited IRA. Additionally, no contributions are allowed in the new, inherited IRA account.
Though it may feel overwhelming to navigate what can feel like complicate tax law during a time of mourning, it is critically important that you make strategic decisions about how to properly handle the finances of the assets you are inheriting, so that you are not inadvertently left with a staggering tax bill. Having a trusted financial advisor in your corner can really help during this emotional time.
We help people understand how inherited assets impact their own financial plan. If you inherit an asset, give us a call. We can help you understand the distribution rules, discuss tax considerations and help you understand the role this asset plays in your own financial planning.
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This content is developed from sources believed to be providing accurate information, and provided by Twenty Over Ten. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.
*Neither Voya Financial Advisors nor its representatives offer tax or legal advice. Please consult with your tax and legal advisors regarding your individual situation.