When a parent dies and their adult child inherits a traditional IRA or you are the beneficiary of a friend’s, knowing what to do can be the difference between an inheritance and a tax disaster. Many people take the money from the IRA account and place it into their own IRA. However, that’s a mistake, says the article “How to manage an inherited IRA from a parent” from Sentinel Source.com.
Any inherited IRA, whether it’s from a parent, sibling, or friend, cannot be simply rolled into your account or treated as if it’s your own IRA. Instead, the assets must be transferred promptly to a new IRA that must be titled an “Inherited IRA” that includes the name of the deceased owner and the phrase “For the benefit of…” and your name. Different financial institutions may have small variations in how they title the account. However, this seemingly small detail is critical.
If a traditional IRA has more than one beneficiary, it must be split into separate accounts for each beneficiary. Each heir will treat their own inherited portion in the same way, as if they were the sole beneficiary.
It’s the heir’s choice to either set up a new Inherited IRA Beneficiary account with a financial institution or advisor of their own or to create a new account using the prior institution. Sometimes using the same firm that held the account is easier, as long as the correct title is used.
The new owner of a Beneficiary IRA needs to know the rules to avoid costly penalties. After the SECURE Act became law in December 2019, most beneficiaries are now required to deplete an inherited IRA within ten (10) years of the original account owner’s death. This applies to any inherited IRAs where the owner has died after December 31, 2019.
The prior rules allowed Inherited IRAs to be depleted over the lifetime of the beneficiary, which allowed the accounts to grow tax-deferred and in many cases, be passed to a third generation, often referred to as “Stretch IRAs.” This option is gone.
There are no limits as to how much or how often withdrawals can be taken from the account, as long as it’s depleted in ten years. However, the withdrawals are taxable as regular income, so if you wait until the ten-year mark and take out the entire amount, you’ll end up with a hefty tax bill.
There are exceptions to the withdrawal rule. A surviving spouse, a minor child, a disabled or chronically ill beneficiary, or a beneficiary within ten years of age of the original IRA owner may have a little more time to withdraw funds (and pay taxes on the withdrawals).
If inheriting an IRA from a spouse, you may transfer the IRA balance into your account and delay distributions until age 72.
Consider your IRAs carefully when working with an estate planning attorney on the distribution of your assets. Will your heirs be able to pay the taxes on their inherited IRAs, or should they be converted to Roth IRAs to relieve heirs of a future tax burden? These are questions that your estate planning attorney will be able to address.
Reference: Sentinel Source.com (Sep. 18, 2021) “How to manage an inherited IRA from a parent”