Inheriting an IRA can be a financial blessing, but you have to be extremely careful about withdrawing the funds. There are a number of mistakes you can make that can result in a missed opportunity for tax deferred growth, or worse, a massive tax bill.
Luckily, surviving spouses have some leeway. It is still tricky to transfer from spouse to spouse. However, the rules for spouses are different from nonspouses.
If you have more than one child or beneficiary, it may seem logical to name the estate as beneficiary. Naming the estate is not always a good idea. If the estate is the beneficiary, your intended heirs will be required to take all of the money out of the IRA or take it out in increments by the end of the fifth year after your death — missing the opportunity to accumulate interest and enjoy the tax sheltering benefit.
Owners of traditional IRAs must start taking required minimum distribution (RMD) when they turn 70 ½. Non-spouse beneficiaries must start taking RMDs upon inheriting the IRA. Thus, the recipient cannot leave the entire amount in the account, allowing it to draw interest. The penalty for not taking RMDs on time is steep. A full 50 percent penalty on the amount that was not withdrawn for the year!
Unfortunately, non-spouse beneficiaries cannot roll an inherited IRA into their own IRA. A separate account Inherited IRA must be set up and titled so that it includes the decedent’s name and the name of the person inheriting an indication of the purpose of the IRA. For example, it might say, “Rhonda Smith (deceased January 7, 2015) IRA for the benefit of Roy Smith.” If you want an account split among beneficiaries, the original IRA must be divided into separate IRAs, and each resulting IRA must be titled for each recipient.
To avoid this pitfall, name your children as beneficiaries of the IRA, and not the estate. By doing so, they will have a lot more flexibility. They can take annual distributions based on their life expectancy which allows them to leave the money in the account and defer taxes.
These issues above are just some of the traps you can fall in when inheriting an IRA. When it comes to transferring IRAs, it is critical to seek the advice of a qualified, experienced estate planning attorney and/or an experienced financial planner. These professionals can help you decide whether or not to withdraw the funds or set up an Inherited IRA.
If you have questions about how to inherit an IRA or if you want to make sure the beneficiaries on your IRA are set up correctly, give our Estrada Law a call at 556-2462 for assistance. Visit our website for other valuable information at EstradaLawPC.com and sign up for one of our no cost no obligation estate planning workshops.