Five Things to Know if You Inherit an IRA

If you inherit an IRA, you have options. What your options are depend primarily on how you are related to the deceased account owner and when the account owner died. Here are five things to know about the options.

1. Spouses can treat the IRA as their own.

If you are the sole beneficiary of your spouse’s IRA, you can elect to be treated as the IRA’s account owner rather than its beneficiary.
If you chose to be treated as the account owner, you will follow the same rules that apply to other account owners. If you inherit a Roth IRA, you do not need to take distributions from the account – ever.

 

2. Eligible designated beneficiaries can take distributions over their life expectancies.

If you are in the “eligible designated beneficiary” category, you have the option to take required minimum distributions based on your own life expectancy from the inherited IRA. This is sometimes referred to as the “stretch IRA” because the annual distributions can be stretched over your lifetime allowing assets that remain in the IRA to compound tax-deferred, or tax-free in the case of a Roth IRA, for as long as possible.

This option used to be available to all individual beneficiaries, but the SECURE Act of 2019 changed the eligibility rules. Now if the account owner dies after 2019, the beneficiary must be an eligible beneficiary to choose this option. If the account owner died in 2019 or earlier, the old eligibility still stands.

Eligible designated beneficiaries include surviving spouses, disabled or chronically ill individuals, and individuals who are not more than 10 years younger than the deceased account owner. They also include the account owner’s minor children, but only until they reach the age of majority at which time, they will be required to withdraw the balance within ten years.

So why would a spouse choose this option? One reason has to do with the 10% early withdrawal tax penalty: it does not apply to account owners. So, choosing this option allows a young spouse who inherits an IRA to withdraw money before age 59 ½ without the 10% penalty fee.

If you decide to take annual distributions, keep in mind that you can withdraw more than the required minimum amount each year – just not less.

3) Most non-spouse beneficiaries must empty an inherited IRA within ten years.

The SECURE Act eliminated the stretch IRA option for most non-spouse beneficiaries. Now if you inherit an IRA from someone who dies after 2019 and you are not an eligible beneficiary, you must withdraw everything from the IRA within ten years of the account owner’s death. You do not have to take distributions every year, but the account must be emptied within ten years.
While it may be tempting to leave the assets to maximize the time they have to compound, consider the tax consequences. If you wait until year ten to withdraw everything, the withdrawal may be large enough to push you into a higher tax bracket. You may be able to minimize taxes on the inheritance by making smaller withdrawals over a few years or by timing your withdrawals to years when you are in a lower tax bracket.

With a Roth IRA, withdrawals are generally tax-free so waiting until year ten will not affect your taxes.

4) You can take a lump-sum distribution.

Anyone who inherits an IRA can withdraw their inheritance in one lump-sum distribution. But before you make a withdrawal, it’s a good idea to make certain you fully understand the tax implications. Assets withdrawn will not be able to compound and the distribution may be subject to income tax that year.

5) You can disclaim the IRA.

One of the first decisions to make when you inherit an IRA is whether you want to accept the inheritance or disclaim it and let it pass to the account owner’s beneficiaries.

Disclaiming the IRA can be an attractive choice in certain circumstances. For example, if you already have sufficient wealth of your own or believe the IRA’s contingent beneficiary may need the money more than you. You may also want to disclaim it if the addition of the IRA assets to your taxable estate will result in increased estate taxes on your estate.

The tax rules for IRA beneficiaries are complex. If you inherit and IRA, please speak to us before you withdraw or move money. We can help you explore your options and decide how to handle your inheritance.

With offices in Rutland and Williston, Vermont Copper Leaf Financial develops a customized wealth management plan designed to integrate every aspect of your financial life. Our approach is to provide clarity and calm amidst the chaos. Where there is uncertainty, we look for facts. We call our approach evidence-based investing. Call us today at 877-974-5341 to schedule a strategy session and begin building your road map to financial success.

Article published in January 2021 edition of Eye on Money. If you would like to be added to our mail list please email jennifer@dh-cpa.com.