If you inherit an IRA, it is crucial that you carefully consider all your options – the wrong decision could cost a great deal in taxes and penalties.
Nonspouse beneficiaries have several withdrawal options available to them; however, all funds must be exhausted within 10 years. Employing the life expectancy withdrawal method could help ensure an even distribution and prevent an untimely distribution that triggers higher tax brackets.
Roll it Over
Beneficiaries who inherit retirement assets typically follow two basic strategies when handling them:epouse Spousal beneficiaries can treat an IRA as their own by transferring funds directly into their individual IRA accounts, or they can create an inherited account in their name and take RMDs using the life expectancy method.
Establishing an inherited account allows its balance to continue growing tax-deferred; however, this process may be complex and require a close evaluation of each beneficiary’s finances and goals.
Timing is everything when it comes to nonspouse beneficiaries; an inappropriate distribution could push them into higher tax brackets and compromise potential tax-deferred growth opportunities. At TIAA Wealth Advisors we can assist beneficiaries with navigating these complex rules.
Disclaim it
IRA funds you don’t want or need can be disclaimed, which allows the money to pass to other beneficiaries instead. This may be beneficial in certain instances – for instance if you expect to retire at age 70 but also have other sources of income such as pension or Social Security payments – making RMD distributions in the interim seem unnecessary, disclaiming may make sense in order to pass it onto them instead.
Note, however, that this option can have serious tax implications if executed improperly; anyone considering it is encouraged to consult a financial expert before making their decision.
Stretch Out Withdrawals
Many nonspouse beneficiaries cannot roll their inheritance directly into an IRA account, but they can choose to withdraw it gradually to keep taxes as low as possible.
Stretch IRAs provide beneficiaries with decades of tax-deferred or even tax-free growth on any assets inherited.
Before making this important decision, beneficiaries should seek advice from an experienced financial professional.
Beneficiaries have the option to withdraw all their inheritance in a lump sum, which will result in a large tax bill and forgoing any future growth opportunities. They could opt instead to take smaller required minimum distributions (RMDs) over their life expectancy to reduce overall taxes; but doing so requires careful timing in order to avoid an untimely distribution that may increase their tax bill or bump them into a higher tax bracket. Beneficiaries should select investment options that align with their financial goals, risk tolerance, and tax situation before doing so.
Take RMDs
Withdrawals from an inherited IRA are taxed at their beneficiary’s ordinary income rate; however, with careful planning they can reduce overall tax impact significantly. Working with a financial advisor, heirs can devise an IRA strategy which takes into account federal income tax rates (currently 10%-15-15-28-33-6.6% but subject to change), as well as state and local income taxes rates which range between 10.15-17.5-15-28%-33.3-39.66%.
Based on their type and date of death, beneficiaries must begin taking required minimum distributions (RMDs) by April 1 of the year following that in which their original account owner would have reached RMD age. Otherwise a penalty tax applies.
Consideration should also be given to federal income tax rates when selecting an RMD method. For instance, those choosing the life expectancy withdrawal method could withdraw assets gradually over five years or more before eventually moving them into their own traditional IRA account.
