(704) 236-6615 scott@southernwa.com

Handling an Inherited IRA

Many people will inherit an IRA from a parent or spouse. The strategies that surround these IRAs involve extending the period over which inheritors must take distributions. With a longer payout period, inheritors can reduce the amount of required minimum distributions which can reduce taxes and let the IRA maintain tax-deferred growth potential. Since inheritors, who are designated beneficiaries under the IRA, are generally able to take withdrawals based on their life expectancy under IRS tables, the younger the beneficiary, the longer the payout period.

Spousal rollovers

A spouse — assume it’s the wife — who inherits an IRA has a choice of whether or not to roll over that IRA into one she already owns. There are two advantages to rolling over the IRA to her own IRA. One is that it enables her to postpone taking distributions until she is 7O ½. The other advantage of this strategy is that the life expectancy table she would use to figure her required distributions would result in a longer payout period than the one that would apply if she remains as the beneficiary of her husband’s IRA.

For example, assume a 70-year-old wife inherits her husband’s IRA after he dies at age 70. If she leaves it in her husband’s name, she must take annual required distributions, starting the year after her husband’s death, over her life expectancy. At age 71, her life expectancy is 16.3 years, according to The Single Life Expectancy Table (for use by Beneficiaries), so she must withdraw about 1/16 of the IRA. Although her life expectancy will be recalculated each year based on her new attained age (so the IRA balance never goes to zero), the IRA would be substantially depleted by the time she reaches her late 80s. And after her death, her remainder beneficiaries would have to withdraw all remaining funds from the account over the remainder of the wife’s life expectancy at her death.

In contrast to this scenario, if the 70-year-old wife rolls over the IRA she inherited from her husband after he died at age 70, the assets have the potential to grow tax-deferred for a much longer period of time. In that case, her annual required distributions are computed using the “Uniform Lifetime Table.” Thus, the first year’s withdrawal will be about 1/27 of the account. With the rollover, the account will not even start to shrink below its value at age 70 until the wife reaches age 90. (That assumes a hypothetical 6% investment return, not representative of any particular investment, and assumes she takes out no more than the minimum required.) Then, at her death, she can leave her IRA to the next generation, who can utilize the stretch-out option over one of their own life expectancies after her death.

So generally, for a surviving spouse, the spousal rollover can be a better choice than leaving the assets in the deceased spouse’s name and taking them as beneficiary. However, if a surviving spouse less than 59½ needs to withdraw from the account, she might want to delay doing the “roll-over” to her own IRA until after she reaches age 591/2, to avoid the 10% penalty tax.

Inherited IRA accounts

A beneficiary other than the surviving spouse (such as a child of the deceased IRA owner) does not have the option to “roll over” the inherited benefits to his own IRA. However, he can hold the IRA as an “Inherited IRA.” The inheritor must begin taking distributions by December 31 of the year following the IRA owner’s death, and can generally stretch them out over his life expectancy (applies to IRAs only). In addition, a non-spouse beneficiary can direct the trustee of another type of inherited plan (such as a 401(k)) to transfer the inherited benefits directly into an Inherited (“beneficiary controlled”) IRA account.

In this case, the inheritor’s distribution options will depend in part upon the terms of the plan from which the account was inherited.

To avoid paying income tax on the entire IRA right away, the account title must include the name of the person who left the funds. For example: “John Doe, deceased, IRA payable to Junior Doe as beneficiary.”

Most married people start by naming their spouse as beneficiary. Although that’s a natural inclination, it may not be the most tax-efficient option.

Splitting accounts for co-beneficiaries

When multiple people are beneficiaries for a single IRA account, it’s a good idea to split the distribution into separate IRAs. All beneficiaries would get the same share they were entitled to under the beneficiary designation form, but could take distributions over their own life expectancies. You will need to take this step before December 31 of the next year following the IRA owner’s death. If you don’t, the payout schedule is based on the life expectancy of the oldest beneficiary.

The stretch-out option

The stretch-out option allows designated beneficiaries of Inherited IRAs to name their own beneficiary, known as the remainder beneficiary. Remainder beneficiaries may continue to receive required distributions after the deaths of both the IRA owner and the original designated beneficiary. The remainder beneficiary continues to receive required distributions based on the non¬recalculating (term certain) method until the payout term is finished. The stretch-out option is not meant to increase the total number of years over which IRA payments are made — it is meant to continue the designated beneficiary’s payout schedule.

The stretch-out option is utilized primarily by non-spouse beneficiaries who cannot roll over Inherited IRAs to their personal IRA.

Disclaiming an IRA inheritance

Beneficiaries who don’t need the money or who want to do some estate planning of their own, can disclaim (decline) the inheritance. This may permit their share of assets to pass to younger beneficiaries, who can achieve a longer stretch-out.

Depending on how the beneficiary designation form is drafted, disclaimed IRA assets can go to either a co-beneficiary, a contingent beneficiary or the owner’s children through a per stirpes distribution — inheritances passed down the branches of a family tree rather than to other members of the same generation. Beneficiaries must work within these parameters when deciding whether to disclaim—it’s not totally up to them where the money should go.

Whenever you disclaim an IRA in-heritance, there are several caveats. Generally a disclaimer must be made within nine months of the IRA owner’s death, and the person disclaiming the inheritance may not have accepted an interest in the asset or any of its benefits. An innocent mistake like changing the way an IRA is invested could taint the disclaimer. When disclaiming property down a generation in order to benefit the grandchildren of someone who has died, generation-skipping transfer taxes may apply, on top of any estate tax if death occurred after 2011.

Estate tax deduction

A beneficiary who inherits an IRA from an estate subject to federal estate tax is entitled to an itemized income-tax deduction for the estate taxes attributable to the IRA (determined by an IRS formula). The deduction applies regardless of who actually paid that estate tax. You can only use the deduction to offset funds withdrawn from the IRA in a given year. This important and often overlooked deduction can be spread out over future tax years until it is used up.

(704) 236-6615

Call Us!


One-Page Financial Plan

Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Independent Advisors Alliance, a registered investment advisor. Southern Wealth Advisors and Independent Advisors Alliance are separate entities from LPL Financial.

The LPL Financial registered representatives associated with this site may only discuss and/or transact securities business with residents of the following states: North Carolina, South Carolina, Florida, Michigan, California, Arizona, and Virginia.

Southern Wealth Advisors
18716 W Catawba Ave
Cornelius, NC 28031