Thursday, March 24, 2016

Dealing with an inherited IRA requires careful planning

If you own a traditional or Roth IRA, it's very important to designate beneficiaries with the official form maintained by the account's trustee. It's also important to update that form as needed whenever there is a relevant life-changing event, such as a divorce or death. Your will's provisions will not override the beneficiary designation maintained by your IRA trustee.
The IRS differentiates between IRAs inherited by spouses and those inherited by other parties. Accordingly, whether you are planning your estate, or expect to be the beneficiary of an inherited IRA, it is important to understand the differences.
If you are the beneficiary of an IRA inherited from a deceased spouse, you have more options than other beneficiaries:
--You may simply change the name on the account to your own. This makes sense if you are satisfied with the investment performance of the IRA and do not intend to change trustees.
--You may establish the account in a new IRA with a different trustee. Ask the new trustee for the paperwork necessary to transfer the account.
--You may roll over the IRA into an account you already have. This makes sense if you want to manage the new IRA in the same manner you are now managing your existing IRAs. (If you are inheriting a Roth IRA, you should only roll it over into an existing Roth account.) Ask your trustee for the paperwork to transfer the funds.
--If you are younger than 59 1/2 and would like to withdraw some funds, establish an "inherited IRA." Your name would be listed as a beneficiary. The account would include the name of the original owner and the date the original account holder died. This allows you to make withdrawals prior to age 59 1/2 and not pay a 10 percent penalty to the IRS. After you reach 59 1/2, re-title the IRA in your name to give you and your beneficiaries more options.
If you are younger than 59 1/2 and inherit a Roth IRA, there is no need to establish an inherited IRA. Try to avoid making any withdrawals from Roth IRAs that have not been established for five years. Otherwise there will be a 10 percent penalty. There is no income tax due or penalty for Roth IRA withdrawals that have been in place for five years.
All withdrawals from traditional IRAs will be taxed at ordinary income tax rates. Accordingly, you should try to "stretch out" withdrawals as long as possible to benefit from the tax-deferred advantage.
If you inherit an IRA but are not the spouse of the decedent, you may not roll the funds into your own IRA. However, you have other options.
--Even if you are younger than 59 1/2, you can withdraw some or all of the IRA assets. You will not have to pay a 10 percent penalty, but all of your withdrawals will be subject to ordinary income taxes.
--You may establish the account as an inherited IRA in your name. This option allows you to maintain the tax-deferred advantage (tax-free if the account is a Roth IRA) for a long while. Based on your age, you will be required to withdraw a percentage of the value of the IRA each year. The minimum amount of the required withdrawal will be based on your life expectancy (tables provided by the IRS) and the year-end value of the IRA. This option is very attractive, and unless you have an immediate need for funds, you should withdraw only the minimum amount required by the IRS.
It is very easy to make mistakes. Work closely with your trustees and knowledgeable financial planners. An excellent source is "The Retirement Savings Time Bomb ... and How to Defuse It," by Ed Slott.