What is the Best Thing to Do With an Inherited IRA?

If you inherit an IRA, there are a few key things you must take into consideration before making any decisions about how best to utilize it. Receiving such an inheritance can be seen as an unexpected boon; making the most out of it is of utmost importance.

Most beneficiaries will need to withdraw funds from an inherited account over 10 years, which could trigger an income tax bill of significant proportions.

Taxes

Inheriting an IRA can be complex. The government wants to ensure that those receiving their inheritance receive required minimum distributions (RMDs) within an acceptable timeline and pay any applicable taxes when withdrawing funds.

Beneficiaries have various options available to them for managing the accounts they inherit, each of which may come with unanticipated tax consequences.

One option would be for beneficiaries to transfer assets into an individual IRA owned by them and treat it as their own account, in order to avoid paying an early withdrawal penalty of 10% early withdrawal penalty, but this means the account no longer qualifies as an IRA and will no longer benefit from tax-deferred growth potential.

Withdrawals

As a non-spouse beneficiary, you have several choices when it comes to handling an inheritance. Your best options depend on when and how soon you need access to the money as well as any tax-free growth opportunities available to you.

Levine suggests transferring assets into an “inherited IRA.” Doing so will force you to take RMDs based on your life expectancy rather than that of the original account holder, potentially minimizing taxes due on RMD withdrawals.

Another option is withdrawing the money immediately; this could result in a significant income tax bill and could push you into higher tax brackets, so it is advisable to speak to a financial planner before making this decision. Remember that by withdrawing these assets they could have potentially enjoyed tax-deferred growth for up to 10 years more!

Rollovers

Dependent upon your relationship to the deceased IRA owner and account type, there may be multiple solutions for how you should treat their assets. Consulting a financial or tax professional could assist in finding the most efficient route forward.

One option for handling inherited assets is rolling them over into an IRA that you own yourself; this allows you to treat it like your own and avoid RMD rules. Another method allows for any withdrawal amounts as long as your RMDs have been taken within five or 10 years after death of original account holder.

Consider using a lifetime income drawdown strategy, which involves shifting distributions toward years in which your income is lower to potentially reduce taxes. Please be aware that this option requires special permission from the IRS, so always seek professional advice before taking this route.

Spousal Transfers

Surviving spouses have the option to treat an inherited IRA as their own and take RMDs based on their life expectancy, rather than that of the deceased person. This allows beneficiaries to “stretch out” withdrawals over an extended period of time in order to reduce taxes due.

As doing so could place them into higher tax brackets in some years when their income is highest, beneficiaries are advised to consult a tax advisor in order to create an overall strategy for managing distributions from an inherited IRA.

Another option would be to withdraw all the balance of an IRA as one lump-sum distribution and pay all applicable taxes in the year of receipt, although this would result in larger total withdrawal amounts but may help avoid an early-withdrawal tax penalty of 10% for distributions made before age 59 1/2.


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