The other evening as I was checking client e-mails, a client sent me a short note inquiring about something her sister did with an inherited IRA and quickly after hearing the story I knew it was even too late to give advice. The sister had told the IRA custodian to make a check out to her Father’s estate and this would cause tax consequences that are irreversible. Inherited IRA’s can be just like a dozen eggs…once you crack the shell it is impossible to put it back together. When a loved one passes away, there is a wide array of emotions, and this could affect how you make short term financial decisions. Especially when you don’t know all of rules or have various siblings chirping in your ear. It is one of the most important times to seek out financial help from a professional.
The overall rules for inherited IRAs are extremely complicated. It really depends if you inherit the IRA as the spouse/partner or you are a non-spouse beneficiary. Typically, spouses can treat the inherited IRA as if it was their own and become the account owner. Or, they can roll it over to a traditional IRA. There are lots of options when it comes to the spouse who inherits the IRA.
However, for non-spouse beneficiaries it becomes far more arduous with the inherited (or some people call it beneficial) IRA.
1. You take the money- If you choose to take the money immediately, then you better be prepared to pay the taxes. If you an inherit an IRA for $100,000, as an example, and you choose to cash the IRA out then it will be including as taxable income the year you take it. The inherit problem is that income will all be taxed at whatever marginal tax bracket you are currently in today, and this could push the tax liability to be 30% or more beyond what you would have to pay in state taxes.
2. Set up the inherited or beneficial IRA correctly- One of the most paramount items is to make sure the IRA is set up in the right manner, especially if you are making a trustee to trustee transfer. A properly established inherited IRA account should include the name of the deceased in its title along with the beneficiary.
3. Make sure you understand what distributions you must take every year- Most investors who inherit an IRA get the money way before they are ready to retire. Often, they aren’t even thinking about the word ‘retirement’. However, it is the responsibility of the beneficiary to take a required minimum distribution (RMD) out of the account every year or take the money out over a five-year period. You can take the RMD over your life expectancy which can help you stretch the IRA over a longer period of time. The strategy behind this will all depend on your personal financial and tax situation.
Remember, RMDs are always calculated on the aggregate balance of all of the qualified retirement accounts you have as of the year end values on 12/31. It’s best that if you inherit multiple IRAs to get them in one location to ease the burden of tracking down all of these numbers to meet your yearly RMD.
There are many pieces of the puzzle to put together when you begin inheriting assets. As Gen X and Gen Y parents are getting older, these are important concepts to understand so you don’t hit yourself with a big tax mistake when you inherit an IRA.
Ted Jenkin is a frequent guest columnist for the Wall Street Journal and Headline News Weekend Express. He is the co-CEO of oXYGen Financial. You can follow him on LinkedIn @ www.linkedin.com/in/theceoadvisor or on Twitter @tedjenkin.
Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. oXYGen Financial is not affiliated with Kestra IS or Kestra AS. Kestra IS and Kestra AS do not provide tax or legal advice.
The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation.