Inherited individual retirement accounts sit in the three-way intersection of estate planning, financial planning and tax planning. The Internal Revenue Service may not grant any chance for a do over. A wrong decision can lead to expensive consequences, massive unexpected taxes, increases in marital or child support, reduction in college aid.
Spouses can leave the money in the account and continue to defer the taxes. Nonspouses have two choices. They can either stretch the payout over their lifetime or they have to take it all out over no longer than five years. The stretch version minimizes the immediate tax impact and maximizes deferment. The stretch option is generally the best deal, so they put deadlines and restrictions on that option. You have to calculate your life expectancy and take distributions based on that calculation no later than December 31 of the next calendar year. If you miss these restrictions then you’re stuck with the five years or less option.
Those Roth IRA’s that you thought would be distributed tax free — they’re taxable if the account was established in the last five years.
If you leave the funds in the existing IRA you live with the successor beneficiary designations made by the original account holder. If you roll the funds over you get to reset the beneficiary designations to your own preferences.
Another issue you may have for Traditional IRA accounts where the owner was more than 70 and a half. These account owners must take required minimum distribution for the year. The required distribution must be taken before December 31 or the IRS will apply a penalty tax before you get the IRA. If you don’t learn about the account until the following year it is to late to do anything.
If you’re getting an IRA from someone with a taxable estate, you get to claim a tax deduction for your prorata share of the estate taxes paid on the IRA. You get the deduction even if the IRA didn’t directly pay the estate taxes related to the IRA.
If the IRA beneficiary form is not complete or not on file with the account custodian you may be stuck with the five year distribution rule. You want a copy of the beneficiary designation on file so that you know it is complete and can produce the terms if the custodian loses theirs.
Designating a trust as the IRA beneficiary can also result in the five year distribution rules.
Mistakes in this area are irreversible. Abatement of taxes an penalties on inherited IRA’s are virtually impossible absent reliance on a private letter ruling. This is an expensive process that takes six months or more.
For assistance in dealing with your inherited IRA give us a call at 907-375-9226.