Just inherited an IRA? Take a moment to consider your options

Marcos- cropped

Marcos A. Segrera, CFP® Financial Advisor

Have you or will you inherit an IRA from someone that is not your spouse?

This is not uncommon. Roughly 42 million US households own some type of IRA. So odds are you know someone other than your spouse who owns an IRA. Play your cards right and you could be a named beneficiary.

If you inherit a Traditional, Rollover, SEP, or SIMPLE IRA from a friend or family member (NOT A SPOUSE), you have several options, depending on whether the account holder was under or over age 70.5 .

If the account holder was under 70.5, here are your choices:

  1. Open an Inherited IRA and use the Life Expectancy Method
    1. Rollover (transfer) the assets into an inherited IRA held in your name. You can open the inherited IRA at places like Charles Schwab, TD Ameritrade, Fidelity, etc. You must begin required minimum distributions no later than 12/31 of the year after the account holder died. Required minimum distributions (RMDs) are mandatory as per the IRS and you are taxed (ordinary income) on each distribution. You will use the IRS Single Life Expectancy Table to determine your annual RMD. Take the value of the account at the end of last year, divide it by the number corresponding with your age on the table and voila. Assuming the account is invested, the undistributed assets can continue to grow tax-deferred. You are also able to name your own beneficiary.
  1. Open an Inherited IRA and distribute within 5 years
    1. Rollover (transfer) the assets into an inherited IRA held in your name. You can open the inherited IRA at places like Charles Schwab, TD Ameritrade, Fidelity, etc. In this case no need to take RMDs. However, the full account value must be distributed by 12/31 of the fifth year after the account holder died. You will need to pay ordinary income taxes on the amount distributed. Undistributed assets can continue to grow tax-deferred for up to five years. You are also able to name your own beneficiary.
  1. Lump sum distribution
    1. Exactly like it sounds, you take a full distribution from the deceased’s IRA and pay all the taxes now. No opportunity for tax-deferred growth. You may move to a higher income bracket depending on the amount of the distribution and your current income level.

If the account holder was over 70.5, here are your choices:

  1. Open an Inherited IRA and use the Life Expectancy Method
    1. Same as above with one detail to note. If the original account holder did not take an RMD in the year of death, an RMD must be taken from the account by 12/31 of the year the original account holder died.

  1. Lump sum distribution
    1. Exactly like it sounds, you take a full distribution from the deceased’s IRA and pay all the taxes now. No opportunity for tax-deferred growth. You may move to a higher income bracket depending on the amount of the distribution and your current income level.

Although your individual circumstances must be taken into account, we typically find the greatest opportunity offered to a non-spouse beneficiary is the ability to open your own inherited IRA and allow the undistributed amount to grow tax-deferred over time. The added flexibility of being able to name your own beneficiary means that this account could stretch significantly beyond your own lifetime and continue growing and providing for future generations. In fact, many IRA owners planning for the future use the stretch feature as a way to comfortably provide for their child’s retirement through the power of tax-deferred compounding.

Sounds wonderful? We agree. Unfortunately, this flexibility may be put to an end with the passing of the SECURE Act (Setting Every Community Up for Retirement Enhancement Act). This legislation, that has already been passed by the House, would kill the stretch provision for non-spouse beneficiaries. The SECURE ACT would require non-spouse beneficiaries to pull out all of the money held in the Inherited IRA within 10 years. The effect would make more of an IRA subject to higher taxes sooner.  We would hate to see such a great planning opportunity be put to bed but we will have to wait on Congress to see where we end up. Don’t hold your breathe.

Do you think you may be inheriting an IRA? Stay tuned or feel free to reach out with questions.

Happy investing.

Marcos

 

Feel free to reach out to Marcos by phone 305.448.8882 extension 212 or email: MSegrera@Evensky.com

 

 

Resources:

https://www.irs.gov/publications/p590b#en_US_2018_publink1000231236

https://www.ici.org/policy/retirement/plan/ira/faqs_iras

https://www.schwab.com/public/schwab/investing/retirement_and_planning/understanding_iras/inherited_ira/withdrawal_rules