Preserving Benefits for Inherited IRA

Inherited IRAOne of the primary benefits of saving in an IRA is the tax-deferred growth on earnings, which provides the compound effect of earnings-on-earnings.  You can benefit even more with a Roth IRA because these earnings can be tax-free.  Unfortunately, this tax benefit is often severely diminished by beneficiaries who make mistakes when handling inherited IRAs. Avoid these errors by taking some simple steps with any IRA that you inherit.

Avoid Unintended Distributions

One of the most common and costly mistakes made with inherited IRAs occurs when a beneficiary requests a distribution when the intent was to transfer the assets. This often occurs when the beneficiary completes the wrong type of paperwork or mistakenly believes that the amount can be rolled over. If you make an unintended distribution, the amount would be included in your ordinary income for the year and therefore would no longer be eligible for tax-deferred (or tax-free in the case of a Roth IRA) growth. The amount could also put you in a higher tax bracket, which may subject your other income amounts to a higher tax rate.

Solution:  When moving assets to your inherited IRA, ensure that the paperwork is for a transfer and not a distribution. Once the assets are distributed from the IRA, they are no longer eligible to be held in an IRA or other tax-deferred retirement account. An exception applies if you are a surviving spouse, as spouse beneficiaries can rollover these amounts to their own IRAs.

Take RMD Amounts

If the IRA owner died on or after reaching the required beginning date (RBD), a required minimum distribution (RMD) must be taken from the IRA for the year that he died. If he did not take this RMD amount, then you must withdraw that amount by the end of the year.  You may also be required to take your own “beneficiary” RMD for IRAs that you have inherited. Failure to take these RMD amounts by the applicable deadline will result in you owing the IRS a 50% excess accumulation penalty.

Solution: Ensure that all RMD amounts are withdrawn before the deadline. If you are unsure about whether you need to take an RMD, contact our offices as soon as possible.  If you missed the deadline due to reasonable causes, the IRS may waive the excess accumulation penalty.

Split Timely for Multiple Beneficiaries

Generally, multiple beneficiaries of an IRA are required to use the life expectancy of the oldest beneficiary when computing beneficiary RMD amounts. This can severely reduce the tax-deferred benefit for the younger beneficiaries, when the oldest beneficiary is much older or the beneficiaries include a non-person such as an estate or charity. For instance, a 45-year-old beneficiary’s distribution period can be reduced from 38 years to five years, if he is one of multiple beneficiaries of an IRA owner who died before the RBD, and one of those beneficiaries is the decedent’s estate.

Solution:  If you are one of multiple beneficiaries, segregate your share into a separate account by September 30 of the year that follows the year in which the IRA owner dies if one of the beneficiaries is a nonperson such as an estate or charity. The deadline is extended to December 31 of the year that follows the year in which the IRA owner dies if there are no non-person beneficiaries.

Work With an Advisor Who Understands IRAs

The rules by which IRAs are governed are many, varied, and often complicated. The assistance of a financial professional who is knowledgeable about IRA rules and regulations can help you to avoid irreversible errors and maximize your tax benefits.

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