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Beneficiaries of an inherited IRA must generally take distributions over their life expectancies unless they’re the spouse or non-spouse beneficiary of its deceased owner. Before making decisions on distributions, beneficiaries should consult a tax professional.
Spouse
Spouses of deceased account owners may treat an inherited IRA as their own and postpone required minimum distribution rules until age 72, but nonspouse beneficiaries must cash out by Dec 31 of the tenth year following original account owner death, or start taking RMDs based on age, with some exceptions for children or disabled beneficiaries.
A surviving spouse can convert an IRA into their own IRA and continue growing the funds tax-deferred. However, in doing so they will owe taxes at ordinary income rates in the year of withdrawal.
Due to a 2005 Supreme Court decision clarifying IRA rules to exclude assets from creditors’ claims, nonspouse beneficiaries no longer enjoy bankruptcy protection for inherited IRAs, so withdrawals should be staggered over 10 years for maximum effect.
Children
IRAs allow account holders to build savings tax-free and distributions are subject to income taxes at their individual tax rates. However, the government still wants its money and requires those inheriting an IRA to take required minimum distributions (RMDs) within an acceptable timeframe and pay any applicable income taxes upon their withdrawals.
Non-spouse beneficiaries typically must withdraw all funds from an inherited IRA within 10 years after its owner has died, either using the life expectancy rule or 10 year rule, or rolling them over into their own IRA and adhering to contributions/distributions/RMD rules and RMD calculations.
Children and other non-spouse beneficiaries should keep in mind that RMDs must be taken out proportionate to the deceased’s IRA balance, meaning if Child A has substantial business losses that enable him to absorb income tax-free, then he could take more than half his share within one year.
Beneficiary Trusts
By designating a trust as an heir, IRA owners gain more control over how their money will be distributed. They can use it to specify specific people such as spouses, children and grandchildren or more broadly define all family members who could receive shares of it; or set rules and stipulations regarding distributions from the trust.
Trustee of conduit trusts must typically pay taxes as their distributions come in, rather than postponing or spreading out payment over time like in an accumulation trust.
Based on their beneficiaries and tax bracket, this type of trust may make sense for some families. Individuals in lower tax brackets could pay less tax with this arrangement because funds will be distributed over multiple years rather than all at once! This is especially beneficial when the trust name charities as beneficiaries.
Estates
IRS requirements stipulate that nonspouse beneficiaries who inherit an IRA must start taking required minimum distributions (RMDs) by December 31 of the year following the original account owner’s death. Detailed rules govern this requirement and vary based on factors like their relationship to the beneficiary, age at death and whether or not RMDs were being taken before death. Beneficiaries should always seek professional guidance prior to initiating required minimum distributions (RMD).
Inherited IRAs may also be distributed according to an accelerated withdrawal schedule known as the 5-year rule, so payments are distributed over their beneficiary’s life expectancy and incur significant tax advantages. This strategy can provide significant tax savings.
No matter their strategy, recipients of an IRA run the risk of moving into a higher tax bracket and must consider this possibility when selecting their distribution option. Consulting a trusted tax attorney or financial advisor on this topic and others related to inheritance assets may provide essential guidance.
