Inheriting an individual retirement account (IRA) can be a great way to receive a financial boost from a loved one who has passed away. However, navigating the rules and regulations surrounding Inherited IRAs is often confusing, particularly given the recent updates brought about by the SECURE Act and SECURE 2.0 Act. Here's what you need to know about Inherited IRAs:
Understand the Basics
Inherited IRAs are designed for beneficiaries who inherit an IRA from a spouse, parent, or other loved one. This type of IRA comes with unique distribution requirements, depending on the beneficiary's relationship to the original account owner.
Consider Your Options
Depending on your situation, you may have different options for how to handle an Inherited IRA. Spouses may be able to roll the account over into their own IRA, which can provide flexibility with distributions and defers taxes until funds are withdrawn. Minor children and certain eligible designated beneficiaries can stretch distributions using a life expectancy method. Nevertheless, most beneficiaries will need to withdraw the entire balance of the IRA within 10 years. Each option has its own set of rules and potential tax consequences. For example, a beneficiary who opts for a lump-sum distribution might receive a windfall of cash, but could face significant tax implications. On the other hand, a beneficiary who stretches distributions over their lifetime might benefit from a steady stream of income, but could also face restrictions on when and how much they can withdraw. It is important to consider all factors before making a decision.
Required Minimum Distributions (RMDs)
It's important to note that if you inherit an IRA from someone who was already taking RMDs, you will need to continue taking them. This means that if the original owner had not yet reached their required beginning date for RMDs, you will have some time before you need to begin taking distributions. However, if the original owner had already started taking RMDs, you will need to continue to take out the minimum based on either their age and life expectancy or possibly your own, until the funds are fully depleted.
Inheriting a Roth IRA
Roth IRA’s that have been held by the original account owner for more than five years are passed to the beneficiary along with their tax-free status. Younger Roth IRAs will be taxed on the earnings. There is no penalty for taking distributions from the inherited Roth IRA, but surprisingly, there is an RMD requirement. Other than spouses, most recipients will need to take RMDs and empty the account by the tenth year.
A Note for Current IRA Owners
It's important to regularly review and update your beneficiaries. If, for instance, you forget to update your beneficiary following a divorce or remarriage, your IRA assets could end up going to an ex-spouse instead of your current spouse or children. Additionally, your heir’s names and details should be updated as they change with life events. On the contrary, failing to designate a beneficiary for your IRA could have significant consequences for your heirs. If your IRA is left without a designated beneficiary, it will be paid to your estate, fully distributed within five years per IRS rules and result in substantial income taxes. This significantly limits the life expectancy of your IRA, reducing its growth potential and ultimately diminishing its benefit to your loved ones. Periodically review your beneficiary designations to ensure that your IRA assets are distributed according to your wishes and in the most tax-efficient manner possible.
Seek Professional Advice
Inherited IRAs can be complex, so it's always a good idea to seek the advice of a financial advisor or tax professional. Fort Vancouver Investment Management can help you determine the best course of action when it comes to your Inherited IRA. Our team of professionals has years of experience working with individuals and families to create personalized financial plans and can help you make informed decisions about your future.