How do Inherited IRAs Work?
The shift from pension plans to 401k style retirement accounts has redefined retirement income savings for a large number of Americans, creating generational opportunities and helping many people live longer, more comfortable lives after working.
IRAs provide a number of advantages, but operate under very strict rules. If you are the beneficiary of someone else’s IRA when they pass on, you may have no idea how inherited IRAs work or about what steps to take to make sure you get the most out of your inheritance.
Understanding Types of Inheritance
You can inherit an IRA in one of two ways:
- As the surviving spouse
- As a non-spouse beneficiary
Distributions from traditional or rollover IRAs are required to start at age 70.5, but distributions from an inherited IRA must start the year after death. A spouse inheritor can choose to rollover and treat inherited IRA assets at their own, after-which it functions just like any other IRA. This may be a good option if you don’t need to access the money or have high income and prefer to defer taxation.
It’s important to note, that Spouses can elect to establish an Inherited IRA, same as the non-spouse beneficiaries below. While distributions must begin in the year after death, you retain the ability to withdraw as much as you want from the IRA without penalty. This is a good option if you desire flexibility in accessing your inherited IRA.
Non-Spouse Beneficiary IRA Inheritances
If you have an inherited IRA that did not come from your spouse, you will have to take the RMDs. To do so, you’ll need to establish an Inherited IRA – and virtually any custodian can do this – and begin your distributions in the year following year.
What’s your Required Minimum Distribution (RMD)?
Some custodians will calculate this for you. I suggest you determine the RMD using the IRS tables and then ask your custodian to verify your calculations. Or you could just ask your financial planner.
Should you cash-out or let it grow?
If it’s a small balance, it may be simpler and cheaper to merely cash it out. If you are subject to RMDs, you’ll must distribute an ever increasing percentage of the account balance which adds to your taxable income unless it’s an inherited Roth IRA. In any case, deferring withdrawals is a powerful strategy for wealth building…so let it grow!