Note: IRA issues can affect multiple generations!
Inheriting an IRA is not like inheriting a car. With an object like a car, the car is signed over to you and it’s yours to do as you please. You can sell it, use it, or gift it.
An Inherited IRA, on the other hand, is not so simple. One small slip and you could lose some tremendous tax benefits or pay a tremendous penalty. No doubt seeing an advisor before doing anything makes sense. And furthermore, since some IRA decisions are time-sensitive, with that timing possibly costing you THOUSANDS of dollars, it’s very important to at least get on the phone immediately with an advisor if you are in the process of inheriting an IRA.
And now, for your enjoyment and education, here are 6 mistakes you want to avoid.
1. If the person who left you the IRA was over 70 1/2, was their required minimum distribution taken yet?
This is one of the more timely issues. IRA owners over the age of 70 1/2 must be taking requirement minimum distributions (RMD). If the RMD is not taken, a 50% penalty tax of the required amount will be assessed. Therefore, if you inherit an IRA, make sure to check this. It’s especially time-sensitive if it’s late in the year and the distributions hasn’t been taken yet. December 31 is the deadline.
2. Beneficiary Forms and Disclaimers
The beneficiary form rules when it comes to where the money will go at death. The will doesn’t matter – what matters is what names are on the beneficiary forms. One thing that you may not be familiar with is the ability to disclaim a beneficiary claim. Let’s say that the primary beneficiaries are you and your child. Since an inherited IRA can be stretched over one’s life expectancy, meaning it can stretch a lot longer with a younger beneficiary, it may make sense to disclaim your share and leave the IRA to your child. This could mean tremendous extra tax-deferred compounded growth for your child.
3. Which brings us to stretching an IRA vs the 5 Year Rule
If you have a chance, make sure that before you die or before your loved ones die, that they plan their asset disbursement by naming beneficiaries. If no beneficiaries are named, then the IRA must follow the 5 year rule and disburse to the estate over 5 years. Compare this to stretching it out over a 40 year life expectancy for example, and you can see all of the lost growth potential. Not exploring a stretch option could be a tremendous cost to you.
4. If you’re a spouse, you can take the money yourself
Spouses have a much better option when inheriting an IRA. They can choose to keep the IRA as an inherited IRA or transfer it to their own IRA. Before you rush to transfer that IRA to your own, note that if your spouse was over 59 1/2 when he/she died, and you are not over age 59 1/2, you can still access an inherited IRA without penalty. You lose this privilege if you transfer the money to your IRA and you are under 59 1/2.
5. IRA trusts as beneficiaries are tricky
IRA owners with large balances sometimes consider creating a trust to inherit the IRA assets and pass them to heirs. They do this because simply leaving the IRA to beneficiaries offers no control over use of the money and some IRA owners don’t want their heirs spending the inheritance irresponsibly. However, a poorly drafted trust could cause the whole thing to be disregarded and trigger the 5 year rule, which is likely not what you would want.
6. Investments may be less than ideal
Oftentimes, older IRA owners will invest in conservative dividend-paying equities, bonds or CDs. However, occasionally people invest in highly aggressive investments, that sometimes lead to lucky gains but leave the possibility of a reversal of fortune. It makes sense that upon inheriting an IRA, to seek professional advice to make sure the investments are suitable for you and the level of risk you are comfortable with.
With all of this said, the most important thing would be to immediately seek at minimum, a phone call with a qualified professional. This is to make sure some of the immediate landmines that might strike are addressed. In other words, first check for disaster prevention, then move on to planning how to handle the inheritance.
If you have questions, feel free to contact us using the IRA questionnaire form below. And remember, this article is not meant as advice specific to you. It is educational to help you make decisions. Talk to an advisor before making any major financial decisions and feel free to contact us with questions.