Americans have nearly $8 trillion dollars in IRA’s (individual retirement accounts). What should you do if you happen to inherit an IRA? The answer can vary depending on many factors such as one’s financial situation, the type of account they are inheriting (i.e. traditional or Roth IRA), and whom (i.e. parent or spouse) the IRA is inheriting from.
What are your options if you inherit a pre-tax IRA from a parent?
1. Lump Sum Distribution:
2. Five-Year Method:
3. Life Expectancy Method:
The best distribution option, in most cases, would be the life expectancy method. By choosing this option, your inherited account will get extra years of tax-deferred growth. You can always take a distribution more than the required minimum in any given year as long as the required minimum distribution is taken each year.
Please note that the early distribution 10% penalty rules do not apply for inherited IRA’s received from a parent. However, if you inherited an IRA from a spouse and you elected to roll the assets into your own retirement account the early distribution penalty rules would apply.
What are your options if you inherit a Roth IRA account from a parent?
The same options as pre-tax Inherited accounts apply:
However, since Roth IRA’s are funded with post-tax income, distributions are received from these accounts tax-free and will not push you into a higher marginal tax bracket.
A big thing to keep in mind is, earnings can be withdrawn tax-free on the first day of the fifth taxable year after the account was established.
For example, a Roth IRA established in 2014, the beneficiary must wait until January 1st, 2019 for earnings on distributions to be withdrawn tax-free.
There are many rules that apply to an individual inheriting an IRA. To maximize the benefits of inheriting an IRA, please contact your Withum tax partner to discuss which distribution options would be best for your individual circumstance.
If you have any questions information regarding inherited IRA’s, or other income tax questions, please contact a member of our Private Client Service Group.