As America ages, it’s likely that more people will inherit substantial Individual Retirement Accounts. What you do next will make a big difference in your own financial future. Yet, few people leave instructions for their named beneficiaries about the best course of action.
Fortunately, there are financial planners who are trained IRA experts, taught by the IRA guru, Ed Slott. At Slott’s website www.IRAHelp.com, you can search for one of Slott’s “Elite IRA Advisors,” like Certified Financial Planner Tony Pondel (www.TPondel.com) in Skokie, Illinois. He recently helped one of my readers avoid a substantial penalty by informing him of the need to take a required minimum distribution from an inherited IRA.
There is such complexity around the rules for inherited IRAs, depending on whether the beneficiary is a spouse or another person, and depending on whether the decedent’s IRA was a traditional IRA or a Roth IRA.
So here’s a look at your options when you become a beneficiary. Before any action is taken, the custodian of the IRA must be presented with the appropriate proof of death of the owner. That allows the custodian to re-title the account as an “inherited IRA” with the name of the decedent and date of death in the title, as well as the name of the beneficiary.
If you are an IRA beneficiary the first rule is: Don’t act too quickly. There are some options that can stretch out tax-deferred growth of your IRA for many years. The second rule is: When you take over an inherited IRA, make sure that you name a beneficiary for it. Then carefully consider the impact of your choices.
Keep the Money Growing
Unless you absolutely and positively need the money right now, the best choice is always to keep the money in an IRA growing tax-deferred (or tax-free if a Roth) as long as possible – subject to the rules that require eventual withdrawals (even from an inherited Roth IRA). If you withdraw immediately, taxes are due in that year, except in the case of a Roth
Also, important: There is no 60-day rollover allowed for an inherited IRA. So if you want to move to a new custodian, or are a spouse who is allowed to roll the inherited IRA into your own, don’t take a check. Instead ask for a direct custodian-to-custodian rollover.
If a spousal beneficiary wants to keep the money growing in the inherited IRA, she must start taking RMDs the year after the original owner’s death, based on her life expectancy. However, if the decedent had already started taking RMDs, the surviving spousal beneficiary must continue taking RMDs but based on her life expectancy. Make sure your custodian uses the appropriate tables.
If she rolls the inherited IRA into her own IRA, she can wait until she reaches age 70-1/2 to start taking RMDs over her own life expectancy. With a spousal IRA, the distributions from a traditional inherited IRA are taxable to the beneficiary as ordinary income. If the original IRA was a Roth, held at least 5 years, the withdrawals are tax-free.
One benefit of keeping an inherited IRA: a young surviving spouse can withdraw money before age 59-1/2 without penalty.
If the beneficiary is not the spouse, the IRA must remain an inherited IRA. The non-spousal beneficiary must start taking RMDs by December 31st of the first year after the account owner’s death, based on the beneficiary’s life expectancy. The exception: If the decedent has already started RMDs, they must continue at the same pace in the year of death. After that year, RMDs continue but based on the life expectancy of the beneficiary. Note: An inherited Roth also has RMDs, even though there was no RMD required by the original owner.
If the IRA was a traditional IRA, the distributions are taxable to the beneficiary as ordinary income. If it was a Roth, the distributions will be tax-free – if the decedent had owned the account for five years.
Bottom line: keeping an inherited IRA growing could benefit you far more in the long run, than taking the money out now. And that’s The Savage Truth.