Maximize an Inherited IRA
Beneficiaries can lose big tax advantages if they do not take the proper steps after inheriting an IRA.
EDITOR'S NOTE: This article was originally published in the July 2011 issue of Kiplinger's Retirement Report. To subscribe, click here.
There's a lot to like about inheriting an IRA, but the gift does come with strings attached. Beneficiaries, especially those who are not the surviving spouse, can easily lose big tax advantages if they do not take the proper steps soon after the death of the parent or other benefactor.
You can keep the money in the tax-deferred account and stretch out distributions -- and tax payments -- over a lifetime. You must take minimum distributions based on your life expectancy, but the rest of the account can grow tax-deferred.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Your first move when you are notified of your inheritance: Warn the IRA's custodian not to liquidate the account and write you a check. If that happens, you will pay tax on the entire account. "It's game-over then," says Rial Moulton, co-founder of Retirement & Tax Planning Specialists, in Spokane Valley, Wash.
Split, retitle and withdraw. If you are one of several beneficiaries, divide up the account. "Establish separate accounts so each can utilize their own single life expectancy," says Doug Zarookian, vice-president and New York branch manager for Charles Schwab.
You must split the account by December 31 of the year following the death of the IRA owner. If the IRA is not split, the size of the withdrawals will be based on the oldest beneficiary's life expectancy.
Say the primary beneficiaries of an IRA are a mother who is age 89 and children who are in their fifties. "Based on Mom's life expectancy, the IRA would have to be paid out rapidly," says Twila Slesnick, co-author of IRAs, 401(k)s & Other Retirement Plans (Nolo, $35). "It would be a disadvantage to the kids."
Nonspouse heirs cannot roll the money into their own IRA. You must open an account for an inherited IRA, and the title must include your name and the name of the person who left you the money. The inherited IRA should be named something like "John Doe's (deceased) IRA for benefit of Susan Doe."
Take special care if your parent named a charity as a beneficiary along with you and other beneficiaries. You must split off the charity's portion by September 30 of the year following the account owner's death. If you don't, the account must be emptied within five years after the owner's death.
A nonspouse heir's first required minimum distribution must be taken by December 31 of the year following the account owner's death. If you miss the deadline, the account must be paid out in five years. A beneficiary who inherits an IRA after the account owner began taking RMDs must take the owner's RMD in the year the owner died, if it was not already taken.
Rules for spouse. Spouses have more leeway than nonspouse heirs. They can either keep the inherited IRA in their deceased spouse's name or roll it into his or her own IRA.
For most spouses, especially younger ones, rolling the IRA into their own account makes sense because they can hold off on taking distributions until age 70 1/2. However, a spouse who is younger than 59 1/2 and taps the account will pay a 10% early-withdrawal penalty.
Younger spouses who need the money early would be better off keeping the money in the old IRA. "Once they attain 59 1/2, they could roll it over to their own IRA," says Zarookian.
Turning down the cash. If an heir, usually a spouse, decides she doesn't need the money, she can "disclaim" the IRA. The money will then pass to the other beneficiaries, usually the children. A disclaimer must be filed within nine months after a benefactor's death.
Because the spouse is refusing the money, the disclaimed amount won't count toward the spouse's $5 million federal estate-tax exemption. A spouse can disclaim a $5 million IRA, pass it on to children who are listed as beneficiaries, and still leave them another $5 million when she dies.
The younger the heirs are, the longer the money can grow. Consider a 20-year-old grandson who gets a disclaimed $50,000 traditional IRA. By taking out the minimum each year and assuming a 6% average return, the IRA could grow to $1.5 million over the heir's lifetime, Moulton says.
-
What Happens Financially When You Work One More Year?
The impact of saving more, spending less later and benefiting from an extra year or more of compounding can be truly staggering.
By Andrew Rosen, CFP®, CEP Published
-
Seven Ways to Spend Your Tax Refund
You may want to splurge, but using your tax refund to save for the future or pay down debt is a much better idea — even if not as fun.
By Kathryn Pomroy Published
-
403(b) Contribution Limits for 2024
retirement plans Teachers and nonprofit workers can contribute more to a 403(b) retirement plan in 2024 than they could in 2023.
By Jackie Stewart Published
-
SEP IRA Contribution Limits for 2024
SEP IRA A good option for small business owners, SEP IRAs allow individual annual contributions of as much as $69,000 a year.
By Jackie Stewart Published
-
Roth IRA Contribution Limits for 2024
Roth IRAs Roth IRA contribution limits have gone up for 2024. Here's what you need to know.
By Jackie Stewart Published
-
SIMPLE IRA Contribution Limits for 2024
simple IRA The maximum amount workers at small businesses can contribute to a SIMPLE IRA increased by $500 for 2024.
By Jackie Stewart Published
-
457 Contribution Limits for 2024
retirement plans State and local government workers can contribute more to their 457 plans in 2024 than in 2023.
By Jackie Stewart Published
-
Roth 401(k) Contribution Limits for 2024
retirement plans The Roth 401(k) contribution limit for 2024 is increasing, and workers who are 50 and older can save even more.
By Jackie Stewart Published
-
Four Tips for Renting Out Your Home on Airbnb
real estate Here's what you should know before listing your home on Airbnb.
By Miriam Cross Published
-
Five Ways to a Cheap Last-Minute Vacation
Travel Procrastinator? No matter. You can pull off a fun and memorable getaway on a moment's notice — without breaking the bank.
By Vaishali Varu Last updated