Wealth Management & Financial Planning

Wealth Management & Financial Planning

What You Should Know About Inheriting an IRA

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They say that only death and taxes are assured, but even “sure things” can cause confusion. Since inheriting an IRA involves both death and taxes, it is important for you to understand the rules and options governing inherited IRAs.

You inherit an IRA when a person has named you as the beneficiary of an IRA or a retirement plan like a 401k. While spouses of the deceased have the option to roll an inherited IRA into their own name, anyone else must accept the IRA as an Inherited IRA.

What are your responsibilities and options when inheriting an IRA? You must begin taking Required Minimum Distributions (RMDs) based on your life expectancy. This means that every year your tax return will report income from the inherited IRA. A common misconception is that an inherited Roth IRA does not require RMD’s. Sadly, that is incorrect. Though the original Roth IRA owner did not have RMD requirements, the beneficiary certainly does.

Unlike a traditional IRA where individuals can choose to convert to a Roth IRA, there is no changing the tax nature of an inherited IRA. The type of IRA inherited will remain fixed forever.

There is no penalty for early withdrawals from an inherited IRA. The rule that imposes a 10 percent penalty on withdrawals made before age 59.5  is gone. You can use an inherited IRA for anything you like at any time, but you do have to report ordinary income on the withdrawal assuming it is not a Roth.

Once the beneficiary is age 70.5, the RMD can be used as a charitable gift to a qualifying charity (QCD). This strategy keeps the distribution from appearing as income on your tax return where Social Security and Medicare payments could be unintentionally increased.

The provision to withdraw IRA funds over your lifetime is known as “The Stretch.” While not part of the tax code, the laws that allow for “The Stretch” reflect the name. These rules have been challenged multiple times and are currently on one of President Obama’s hit lists should the current budget proposal be passed. While the opportunity to stretch IRA funds over a lifetime may go away,  we will use it while we can!

The other significant difference between a traditional IRA and an inherited IRA came about in 2014 when the Supreme Court ruled that Inherited IRAs did not have bankruptcy protection. Though this rarely matters to people who own resources like IRA’s it can matter greatly to a beneficiary! You should always know the financial condition of those you are leaving assets to in order to insure the right asset goes to the right individual from a tax perspective. Just as your assets are different, so are the financial situations of your heirs.

Inherited IRA’s can be confusing to recipients but they aren’t that difficult. They must be titled correctly and recipients must take the RMD. These instruments become pretty straight forward when the rules are understood.

Tax advice provided by CPAs affiliated with the Financial Enhancement Group, LLC.

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 my Disclosure page for full disclaimer.[/vc_column_text][/vc_column][/vc_row][vc_row][vc_column offset=”vc_hidden-lg vc_hidden-md vc_hidden-sm”][vc_widget_sidebar sidebar_id=”sidebar-main”][/vc_column][/vc_row]

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