Inherited IRA rules can complicate estate planning.
Although some jobs still have pensions, this is increasingly more uncommon.
In place of pensions, most people now have “defined-contribution” through individual IRAs or employer- sponsored retirement plans (think 401(k) or profit-sharing) plans.
Several rules govern how these are taxed and what needs to be withdrawn during retirement.
According to a recent The Motley Fool article titled “Understanding Inherited IRAs,” IRAs are helpful for retirement savings but can be messy when it comes to estate planning.
In fact, I find planning for retirement funds one of the most complex aspects of a comprehensive estate plan.
What are some of the rules governing an inherited IRA?
Those who are beneficiaries of an IRA open an “inherited” IRA account.
This is a tax advantaged investment account used to received funds transferred from the IRA of the individual who died owning it.
The beneficiary of an IRA is usually a spouse, child, other relative, or friend of the person who died.
When someone designates more than one beneficiary, then each beneficiary must open his or her own inherited IRA account.
These accounts can only hold the inherited funds.
Beneficiaries are not allowed to add other funds into these accounts.
If the beneficiary is a surviving spouse, then the funds may defer taxes and required minimum distributions until the surviving spouse retires at reaches age 72.
Why would this be helpful?
By not having to make withdrawals, the funds would be able to grow over a longer time.
Generally, the funds on an IRA will trigger a 10 percent penalty if they are withdrawn prior to age 59½.
The exception would be if the funds are in a Roth IRA and it has been at least five years since the rollover was completed.
Can the funds be withdrawn from a inherited IRA in a lump sum?
This will usually lead to a high tax bill.
If the funds were in a Roth IRA owned by the original owner for at least five years, then you can avoid a significant tax bill from a lump sum withdrawal.
Beneficiaries who were not a spouse should not place the funds in their own IRA and will need to completely withdraw the funds within five or ten years of the death date of the original owner.
Required minimum distributions must be take from the inherited IRA according to the distribution period for your age listed in IRS Single Life Expectancy Table.
Failing to take out the RMD will lead to a 50 percent penalty on what should have been taken.
Non-spouse beneficiaries are only eligible to use the life expectancy method if the original owner died in 2019 or earlier and if they meet one of the following criteria.
These include being disabled or chronically ill, being no more than ten years younger than the original account owner, or being a minor child of the original owner.
If a minor child, the life expectancy method only applies until the individual reaches age 18.
Because inherited IRA mistakes can be expensive, work with an experienced estate planning attorney to ensure they align with your comprehensive estate plan.
Reference: The Motley Fool (Aug. 18, 2022) “Understanding Inherited IRAs”