An inherited IRA requires special attention.
Your parents or your spouse were hard workers.
They were also good savers.
During their careers, they allocated money each year to their retirement savings.
Upon their deaths, you inherited the IRA.
According to a a recent Kiplinger article titled “I Inherited an IRA. Now What?,” your relationship to the individual who left you the IRA is important.
No, it is essential.
Your relationship will determine your status as a beneficiary under the SECURE Act.
Consequently, this categorization will subsequently impact what actions you should take with the inherited IRA.
Failing to account for these nuances could cause problems with the IRS.
An addition to your relationship status, you should consider is whether the inherited IRA is a Roth IRA or a traditional IRA.
If the account is a traditional IRA, the original owner is required to take a required minimum distribution (RMD) withdrawal each year starting when the owner turns 72.
If the owner was older than 72, you should check to see if the RMD was taken for the year he or she died.
If not, a withdrawal must be made.
Failing to do so could result in a significant penalty from the IRS.
Additionally, you should gather information regarding when the account was opened and whether you are the sole beneficiary.
After taking these steps, what options might you consider?
Transfer the Funds to a New IRA.
This option is available if you inherited the IRA of your spouse.
When you inherit, you can elect to transfer the assets held in the IRA of your spouse into your own new or existing traditional or Roth IRA.
You can even do so if your spouse was over age 72 and already making RMD withdrawals.
What are the benefits of this method?
If you are younger than your spouse, transferring the funds can allow you to place the money into a traditional fund and delay taking required minimum distribution until you reach age 72.
Should you choose to transfer to your own Roth IRA, you would be not be required to make withdrawals.
By transferring the funds to your own account, you cannot make withdrawals from the account until you are at least age 59½ without incurring a 10 percent early withdrawal penalty.
Spousal Stretch IRA.
Another option available for spouses who inherit an IRA is to transfer these funds into an inherited IRA.
How is this different from a transfer into your own IRA account?
The inherited IRA will require you to first open an account with the same institution as the original IRA.
You can then open an account at another institution.
After doing so, you can request a “direct IRA-to-IRA transfer.”
With an inherited IRA, you have two options for withdrawals.
The first option is to take annual distributions based on your own life expectancy rather than the life expectancy of your spouse.
The other option is to withdrawal all funds within 10 years.
Options for Non-Spousal Heirs.
If you inherited an IRA but are not the spouses of the original owner, your options are limited.
The SECURE Act removed the option for you to utilize a “stretch” IRA.
You must completely withdraw funds from the inherited IRA within 10 years of the death of the original owner.
This rule applies to both Roth IRAs and traditional IRAs.
There are some exceptions to these rules.
Minors, certain disabled individuals, or those more than ten years younger than the original owner can utilize a stretch IRA.
If you are in the category of individuals required to withdraw all funds within 10 years, you have the option to take withdrawals throughout the 10 years or allow the money to grow tax-deferred and withdraw all of it at the end.
If you choose to take a lump sum from an account, you may move into a higher tax bracket for the year of the withdrawal.
With a traditional IRA, you will need to pay income taxes on the withdrawal.
With a Roth IRA, you will not owe income taxes as long as the account was opened at least five years before your withdrawals were made.
By understanding your relationship to the original owner, you will be equipped to make wise choices with your inherited IRA.
Engage the services of a financial advisor who specializes in retirement planning.
Too much is at stake.
Reference: Kiplinger (Aug. 4, 2021) “I Inherited an IRA. Now What?”