Inheriting an IRA can be a financial blessing but you have to be extremely careful about withdrawing the funds. There are a number of mistakes you can make that can result in a missed opportunity for tax-deferred growth, or worse, a huge tax bill.
Luckily, surviving spouses have some leeway. It’s still tricky to transfer from spouse to spouse. But the rules for spouses are different than non-spouses.
If you have more than one child, it may seem logical to name the estate as beneficiary. This is not always a good idea. In this case, your children will be required to take all of the money out of the IRA by the end of the fifth year after your death – missing the opportunity to accumulate interest and enjoy the tax sheltering benefit.
Owners of traditional IRAs must start taking required minimum distribution (RMD) when they turn 70 ½. Non-spouse beneficiaries must start taking RMDs upon inheriting. This means you can’t leave the entire amount in the account, allowing it to draw interest. The penalty for not taking RMDs on time is steep. A full 50% penalty on the amount that should have been withdrawn for the year!
Unfortunately, non-spouse beneficiaries can’t roll an inherited IRA into their own IRA. A separate account Inherited IRA must be set up and titled so that it includes the decedent’s name and the name of the person inheriting an indication of the purpose of the IRA. For example, it might say, “Rhonda Smith (deceased January 7, 2015) IRA for the benefit of Roy Smith.” If the account is split among beneficiaries, the original IRA must be split into separate IRAs and each one must be titled in the same manner.
To avoid this pitfall, name your children as beneficiaries of the IRA, and not the estate. By doing so, they will have a lot more flexibility. They can take annual distributions based on their own life expectancy which allows them to leave the money in the account and defer taxes.
Roth (not traditional) IRAs can usually be withdrawn tax-free. But, they’ll be prohibited from depositing them into their own IRAs and they’ll have to pay taxes on the whole amount.
These issues above are just some of the traps you can fall in when inheriting an IRA. When it comes to transferring IRAs, it is critical to seek the advice of a qualified, experienced estate attorney in Orange County. They can help you decide whether or not to withdraw the funds or set up an Inherited IRA.
If you have questions about how to inherit an IRA or if you want to make sure the beneficiaries on your IRA are set up correctly, give our Orange County law firm a call at (949) 260-1400 for assistance.