Spouses have more choices with an inherited individual retirement account (IRA)
Most nonspouse beneficiaries must deplete an inherited IRA within 10 years
A knowledgeable professional can help you navigate an inherited IRA
Tax laws surrounding inheritances are always changing, and it’s impossible to say for certain when the next change will come. If you have an inherited IRA, it’s important to understand the implications—including when it might be time to bring in a financial advisor or tax professional to help you navigate these tricky waters.
Spouses Have More Choices
First of all, there’s a difference when you inherit an IRA from a spouse. You can choose to treat the inherited IRA as your own or roll the money over into your own account. When completing a rollover, it’s important to make sure the tax treatment of the inherited IRA is the same as your existing IRA. As a spouse, you can also disclaim the money, allowing it to go to the next beneficiary in line.
Avoid an oops: If you decide to treat an inherited IRA as your own, watch out for the possibility of an early withdrawal penalty. Tapping the funds before age 59 1/2 could lead to a 10% additional penalty. Double-check with a tax professional before making a move.
Nonspouses Can No Longer “Stretch” an Inherited IRA
In the past, nonspouse individual beneficiaries could use a life expectancy calculation to figure out how much to take from an inherited IRA. This was a way to reduce the tax burden on the beneficiary. However, since the passage of the SECURE Act, things have changed.
Now, most nonspouse beneficiaries are required to draw down the inherited IRA within 10 years. As a result, some beneficiaries find themselves taking larger chunks out of inherited IRAs—and paying higher taxes.
Exceptions to new inherited IRA rules: Some nonspouse beneficiaries can still use the life expectancy method. These exceptions include those who are chronically ill or disabled, as well as those who are only 10 years younger (or less) than the deceased IRA owner. Another exception is a minor child of the original account owner. However, once the child reaches the age of majority, the clock starts ticking and they must deplete the inherited IRA within 10 years.
Pay Attention to Details
Realize that no matter what’s in the will, an inherited IRA goes to the beneficiary listed on the paperwork. On top of that, it’s important to understand whether the deceased IRA owner had already taken a required minimum distribution (RMD). Recently, the age for RMDs was increased to 72 from 70 1/2, so this might change the calculus when you’re reviewing the details.
For 2020: Due to the CARES Act, RMDs are not required.
Don’t forget to double-check tax laws for changes to estate taxes and inheritance taxes. You might be eligible to receive a tax deduction based on estate taxes paid on the account. For example, if an estate tax was levied at the time of the IRA owner’s death, you might be able to take a tax deduction when you make a withdrawal from the inherited IRA, potentially reducing your tax liability.
Avoid an oops: A tax professional can help you figure out what taxes are owed and what tax breaks you might be entitled to. Consider looking for a professional who specializes in these issues to help you figure out how to manage the details.
Integrate an Inherited IRA into Your Retirement Plan
Receiving an inherited IRA can change the equation on your own retirement planning. You might feel the need to adjust your plans based on an inheritance and other factors. With the help of the TD Ameritrade Retirement Calculator, you can get an idea of how to move forward based on the assets you already have, as well as on what you can expect in the future.
When you receive an inherited IRA, it can change how you withdraw from your tax-advantaged retirement accounts, as well as impact your tax situation. You might adjust when you decide to take Social Security benefits or how you approach your retirement investment portfolio.
A good calculator can help you get a handle on the situation, especially if you follow up by consulting a retirement specialist who might be able to help you create a retirement road map that includes all the factors.
An inherited IRA can make a big difference in your life. But you need to be aware of some of the sticky situations that can arise. If the paperwork isn’t in order, things can get messy. Plus, it’s a good idea to be aware of how changing tax laws might impact how you manage an inherited IRA.
Are you trying to figure out how to pass on your own IRA? Consider estate planning, including a creating a will or living trust. Review your IRA documents to help make the inheritance process as easy as possible for those you leave behind. Planning is the true gift of inheritance.
TD Ameritrade does not provide legal or tax advice. Please consult your legal or tax advisor before contributing to your IRA.