Written by: Spencer Salvador
This post was originally published on our previous blog website on September 5, 2017 and has since not been revised and/or updated.
Last week, Spencer Salvador walked us through inheriting an IRA from a spouse. This week, he will walk us through inheriting an IRA from someone other than a spouse. Take it away, Spencer!
Inherited IRA From Someone Other Than a Spouse
Pre-Tax IRA – Traditional IRA, SEP IRA, SIMPLE IRA
If you’ve inherited a pre-tax IRA from a non-spouse there’s two main options for what to do. The decision, in large part, comes down to your financial goals and current situation.
Option 1: Transfer the account to an Inherited IRA
*Please note there are special requirements for actions and accessing the money under this option
- Benefits:
- The assets in the account can continue to grow tax-deferred over time.
- You are able to designate your own beneficiaries in the event you pass before taking full distributions.
- You do not have to pay an early withdrawal penalty when receiving distributions prior to 59 ½.
- Actions:
- Talk to your financial advisor before making this decision on your own.
- If you are the sole beneficiary of the account all you’ll need to do is transfer the assets into an Inherited IRA held in your name.
- Be sure to review the allocation so it is appropriate for your goals and time horizon.
- The account registration should include the original account holder’s name, an indication that the account is an IRA beneficiary distribution account, and your (the inheritor’s) name.
- If the account is to be split amongst multiple beneficiaries you’ll need to establish a separate account by December 31st following the year of death to use your own life expectancy for RMDs. If you miss this deadline, the RMDs will be calculated using the oldest beneficiary’s life expectancy.
- Be sure to review the allocation so it is appropriate for your goals and time horizon.
- Accessing the money:
- Money in Inherited IRAs is available at any time without an early withdrawal penalty.
- Most distributions are taxable as income when withdrawing the money.
- You may use your life expectancy when calculating RMDs, however the RBD depends on the original account holder’s age:
- Account holder was over 70 ½ years old:
- RMDs must begin by December 31st of the year after death.
- If the account holder did not take an RMD for the year they passed away, you must take the RMD before the end of the year in which they passed.
- Account holder was under 70 ½ years old:
- RMDs must begin no later than December 31st following the year of the account holder’s passing, or
- You may also delay the distribution out to December 31st of the 5th year after the year of the account holder’s death and at that time take a full distribution of all assets in the account.
- Account holder was over 70 ½ years old:
Option 2: Receive a lump-sum distribution
- Benefits:
- You do not have to pay an early withdrawal penalty when receiving distributions prior to 59 ½.
- Actions:
- Talk to a tax professional and your financial advisor before making this decision on your own.
- Transfer the assets into an account in your name and take an immediate lump sum distribution.
- Accessing the money:
- Money is distributed in a lump-sum all at once.
- Most distributions are taxable as income when withdrawing the money which may move you into a higher income tax bracket in the year distributed.
Post-Tax IRA – Roth IRA
If you’ve inherited a post-tax IRA (Roth IRA) from a non-spouse the options you have are very similar to the options for a pre-tax IRA. That said, options for accessing the money from inherited Roth IRAs carry certain stipulations which are important to be aware of.
In general, qualified distributions from Roth IRAs occur once you’ve obtained age 59 ½ and assets have met the five-year holding period requirement. The five-year rule stipulates that at least 5 years have passed since the tax year of the first Roth IRA contribution in order to access the money tax-free.
Option 1: Transfer the account to an Inherited IRA
*Please note there are special requirements for actions and accessing the money under this option
- Benefits:
- The assets in the account can continue to grow tax-free over time.
- You are able to designate your own beneficiaries in the event you pass before taking full distributions.
- You do not have to pay an early withdrawal penalty when receiving distributions prior to 59 ½.
- Actions:
- Talk to your financial advisor before making this decision on your own.
- If you are the sole beneficiary of the account all you’ll need to do is transfer the assets into an Inherited Roth IRA held in your name.
- Be sure to review the allocation so it is appropriate for your goals and time horizon.
- The account registration should include the original account holder’s name, an indication that the account is an IRA beneficiary distribution account, and your (the inheritor’s) name.
- If the account is to be split amongst multiple beneficiaries you’ll need to establish a separate account by December 31st following the year of death to use your own life expectancy for RMDs. If you miss this deadline, the RMDs will be calculated using the oldest beneficiary’s life expectancy.
- Be sure to review the allocation so it is appropriate for your goals and time horizon.
- Accessing the money:
- Money in Inherited Roth IRAs is available at any time without an early withdrawal penalty.
- Money in Inherited Roth IRAs is generally tax-free as long as assets have met the five-year holding period.
- You may use your life expectancy when calculating RMDs but:
- RMDs must begin no later than December 31st following the year of the account holder’s passing, or
- You may also delay the distribution out to December 31st of the 5th year after the year of the account holder’s death and at that time take a full distribution of all assets in the account.
Option 2: Receive a lump-sum distribution
- Benefits:
- You do not have to pay an early withdrawal penalty when receiving distributions prior to 59 ½.
- Actions:
- Talk to a tax professional and your financial advisor before making this decision on your own.
- Transfer the assets into an account in your name and take an immediate lump sum distribution.
- Accessing the money:
- Money is distributed in a lump-sum all at once.
- Money is generally tax-free as long as assets have met the five-year holding period.
What Are Your Financial Goals?
There’s no “one-size fits all” solution here. Evaluate your goals and financial situation to help decide which of the above options makes the most sense for your circumstances.
As I previously mentioned, in some circumstances, the passing of a loved one could cause financial hardship so it’s important to determine whether or not you’ll need to access a portion or all of the inherited account in the foreseeable future. For some, there is no immediate need for the inheritance so you can allow the account to continue to grow (hopefully) over time and turn the assets into a long-lasting legacy.
If you’re not sure what makes the most sense, get a 2nd and 3rd opinion from a financial professional and someone impartial to your situation. If you feel you know exactly what makes the most sense, still get a 2nd and 3rd opinion from a financial professional and someone impartial to your situation as they may be able to point out things you haven’t considered.
Conclusion
Yikes. I feel like I just gave kids a loaded gun (no offense). Re-read the paragraph just above this.
Disclosure:
This is not to be construed as individualized financial or investment advice. Consult with your financial advisor for specific recommendations regarding your particular circumstances.
Financial Advisors do not provide specific tax/legal advice and this information should not be considered as such. You should always consult your tax/legal advisor regarding your own specific tax/legal situation.
