Wealth Management & Financial Planning

Wealth Management & Financial Planning

IRA Beneficiary

There are Rules When You Inherit an IRA

Inheriting an IRA is rarely fun. One reason, it means you lost a person who thought enough of you to be a beneficiary. Another, they can also be very confusing. The new tax changes added to the complexity.

There are essentially three types of beneficiaries. You can name your spouse if you are legally married, another person who is not your spouse, and a charity. You could leave it to your estate, but that would rarely be the best option.

If you are the surviving spouse, you can roll the IRA and qualified retirement accounts into your name directly. There is no tax penalty and no reason not to do this if you are over 59.5 years of age. The normal rules would then apply to this account, just like your other IRA money.

If you are under age 59.5, you may want to leave the account in the inherited IRA status. That allows you to access income if necessary, with no tax penalty but full taxation. If you transferred the money into your own IRA and made withdrawals, you would have a 10% federal penalty attached to the normal taxation.

If you are the child or another beneficiary, and your benefactor dies after January 1, 2020, then you will have to remove all the proceeds in the account by the end of the 10th year. There are some exceptions to this rule – minor children, chronically ill, beneficiaries within ten years of the age of the benefactor, and permanently disabled – where the accounts can be emptied over more extended periods. These changes are all part of The Secure Act.

The rule change applies whether this is tax-deferred money or Roth accounts. If tax-deferred like a traditional IRA, you would pay income taxes at your top marginal rate upon withdrawing. If you allow the accounts to build over the ten years, you may have one large tax bite. A better strategy may be to create a withdrawal plan to recognize some of the income along the way. You don’t have to spend it, but you may very well want to pay taxes at lower possible rates.

The tax code changes bring in a whole new level of planning. The complexity of distribution and understanding taxation can be overwhelming. Along with taxation issues, you will need to consider the types of investments in the accounts, knowing the money must be withdrawn in the ten years.

You will also want to plan for the impending taxation. If you had no other assets, and a larger IRA that you inherited, you could find yourself in a situation where you had to make withdrawals to pay the taxes on the money you withdrew for taxes! That may be an awkward sentence but no more frustrating than making a withdrawal for income, making a withdrawal to pay the taxes on that withdrawal, and then taking even more to pay the taxes on the taxes. Welcome to tax deferral – the dark side of retirement.

You, as the current owner and you as a potential beneficiary, all have choices. But you need to act sooner than later for the best planning strategy.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see our Disclosure page for the full disclaimer.

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