Did you inherit an IRA or know you’ll be the beneficiary of an IRA? Know the rules outlined by the SECURE Act so your money doesn’t get eaten up by 50…
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This story originally appeared on MarketBeat
Do you expect to inherit the contents of an individual retirement account (IRA)? If you are not the spouse of the individual who died and inherited IRA money, you want to know the new withdrawal rules. For example, if someone in your family (such as a parent, a grandparent, aunt, uncle, sister, brother, etc.) passes away and leaves you money in an IRA, you want to know the new withdrawal rules through the Setting Everyone Up for Retirement Enhancement (SECURE) Act. The SECURE Act has been around for a little while — but long enough for people to forget all about this added rule.
The IRS will levy huge penalties on the account your loved one leaves you if you don’t follow the rules. Here’s how to prevent that from happening and tips about inheriting IRA assets as a beneficiary (but not a spouse).
Tip 1: You must take distributions within 10 years.
Inheriting rules depend on your relationship to the original IRA owner and the type of IRA you inherit. You must take IRA distributions within 10 years following the death of the account owner. You can no longer pace your withdrawals to last over a long lifespan, such as 30 years.
According to the SECURE Act, you won’t have to take specific required minimum distributions (RMDs) during each of those 10 years. At the end of the 10th year after the original owner died, you must have an empty account. If the account isn’t empty, the IRS will levy a 50% penalty tax on the money that remains in the account.
Let’s say a parent dies and leaves $1 million to his two children. The adult children, ages 50 and 53, can choose one of three options:
- Option 1: Withdraw the entire balance of $500,000 (each) in one year.
- Option 2: Spread it evenly over 10 years by withdrawing $50,000 each year to cushion the tax impact.
- Option 3: Take various amounts each year based on their specific tax bracket in a given year.
No matter what, the children must withdraw the entire amount by the 10th year.
Tip 2: You can’t roll money into an existing account.
The IRS doesn’t allow you to roll the money from an inherited IRA into one of your existing accounts. You must transfer your portion of the assets into a new IRA set up and formally named as an inherited IRA. You cannot make contributions to this account.
Tip 3: Meet with a tax advisor.
You want to talk with a trusted tax advisor because all money is taxed as ordinary income. This might mean taking withdrawals over multiple years to help you avoid rocketing to a higher tax bracket. A few options that your tax advisor might help you consider:
- Make a charitable donation: Your tax deduction toward the charitable donation could help offset the additional tax you owe on an inherited IRA distribution.
- Make a qualified charitable donation (QCD): A QCD is a direct transfer of funds from your IRA to a qualified charity. Amounts distributed as a QCD can count toward satisfying your RMD for the year, up to $100,000. You can only do this if you’re at least 70 ½.
No matter which strategy you choose, chat with your tax advisor for more information.
Tip 4: Roth IRAs work differently.
Since you don’t have to take out RMDs and withdrawing the money from a Roth IRA won’t trigger a tax bill, a non-spouse who inherits a Roth IRA might consider waiting until the last possible minute to empty the account. You’ll get another 10 years of tax-free growth before moving money into a taxable account. However, just don’t forget about it. The money must be withdrawn at the 10-year mark.
Roth IRA beneficiaries can withdraw contributions tax-free at any time. You can withdraw earnings tax-free as long as the account had been open for at least five years at the time the account holder died. If the account was less than five years old at the original owner’s death, you’ll owe taxes on the earnings you withdraw.
Tip 5: Consider timed withdrawals.
You may want to consider timed withdrawals, which means you spread withdrawals out over those 10 years.
Just note that with a traditional IRA, each withdrawal counts as income and you will pay taxes in the year you make the withdrawal. Your tax advisor can give you more information about how these withdrawals will affect your tax bracket.
Tip 5: The 10-year rule doesn’t apply to everyone.
In several situations, you can use the old RMD method, which refers to the “stretch” RMD methods — that you withdraw based on life expectancy. The rule doesn’t apply to:
- Minor children: You must take distributions but they’re based on life expectancy. This only applies until you’re 18 in most states. Once you turn 18, you must withdraw the account within 10 years.
- Those chronically ill or disabled: You can stretch IRA distributions out over your lifetime if you’re chronically ill or disabled.
- Those not more than 10 years younger than the account owner: You can stretch withdrawals out over your lifetime.
Tip 6: You’ll face different rules for IRAs inherited by an estate or trust.
Talk with your tax advisor about what you should do when an IRA gets inherited by an estate or trust. The account must be fully withdrawn within five years in most cases.
Tip 6: Find out in advance whether you’re someone else’s beneficiary.
When you find out that someone left you an IRA, you might have been surprised to learn that the deceased had considerable assets stacked up. If you have others who might list you as a beneficiary, find out now — don’t wait for a surprise inheritance. It’s the only way you can plan your financial life for the future (and talk with a tax professional as soon as you know about it).
Know the New Rules and Talk with a Tax Professional
The old rules stated that you could take out money over your entire life expectancy. Cumulative tax impacts could affect you more when it’s compressed into a 10-year period, particularly when you put that together with your other income. Generally, your distribution is included in your gross income and will be subject to ordinary state and federal income taxes.
Consider all your options when taking RMDs and other distributions and talk to a tax professional to reduce your burden as much as possible.
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