What is it like to get an inherited IRA?
If you are ever asked by a relative if there is anything that you are emotionally attached to and who like to receive at their passing, tell them yes, your Roth IRA…
It’s a great thing to inherit, not income tax, and can grow for an additional ten years tax-free.
Leaving someone an interest in your regular IRA or 401K plan is still a blessing. However, it can also become a problem if it is not handled correctly, according to CNBC in “Leaving an IRA to a loved one? How to avoid a tax bomb.” You can structure the distribution so that your children or grandchildren receive the best benefits.
Rules have changed dramatically since 2019, allowing most inheritors to keep the funds in an IRA for shorter time periods. Generally, that is now ten years, with a few notable exceptions: Spouse can roll the funds over into their own IRA and stretch the funds over their life expectancy. For minor children, the ten-year period starts at age 18. Someone within 10 years of the account owner’s age can use their own life expectancy. A special-needs beneficiary may have their own life expectancy for withdrawals.
In certain circumstances, it can be good to designate a trust as IRA beneficiary, as it provides some control and protection over the funds. By naming a trust, you can protect heirs who are minors, vulnerable to creditors, not able to handle large sums of money, or disabled. However, Trusts need proper drafting to allow the above exceptions to apply, and trustees will need advice on handling withdrawals, distributions, and tax filings.
If you don’t structure the trust and beneficiary designation correctly, you could accelerate the liquidation of the inherited IRA at warp speed.
Most people think of their spouse when naming a beneficiary for an IRA. If your spouse doesn’t need the funds, you should consider providing for the next generation, who will live in a world of “You’re on your own” retirement planning. To do this, it is imperative that you have correctly named contingent beneficiaries.
We advise our clients and their families to consult with us before rolling over or withdrawing IRA accounts. Important planning opportunities can be lost by moving retirement accounts too quickly after someone dies, as we can’t put accounts back once they have taken.
Except for spousal rollovers, inherited IRAs are within the reach of a beneficiary’s creditors unless protected in a trust.
If a trust is designated, we suggest having separate subTrusts for each beneficiary named on the designation form. This allows separate management for the different shares and removes the successor trustee of your trust from needing to manage withdrawals from each beneficiary over potentially a ten-year distribution plan.
What are the pitfalls? Not all IRA custodians allow you to list a trust on the beneficiary form. The tax code imposes very specific conditions on trusts that are beneficiaries of retirement accounts. Be very careful about how you handle charities as beneficiaries. IRAs can be great tools for charitable giving, but must be handled with great care to avoid tax problems. If you fail to follow the rules, your heirs could face huge tax bills.
An estate planning attorney can advise you in creating an estate plan that fits your unique circumstances and can include an inherited IRA that works best for your loved ones.
Reference: CNBC (Dec. 9, 2018) “Leaving an IRA to a loved one? How to avoid a tax bomb”