Suppose you receive an inheritance from a parent, grandparent, aunt, uncle, or some other significant other in the form of an IRA, 401k, or other type of retirement account.

What do you do?

Well, there are many benefits from an Inherited IRA, but handling it wrong could be costly.

If you are a spouse, the IRA can be incorporated into your own IRA. Done.

If you are a non-spouse, you have 3 options:

1.) A Lump Sum Distribution
You take the money and run. However, you will have to pay taxes on the entire amount in that year’s tax return. Why? Because you are taking it out of the IRA. Depending on the amount of the Inherited IRA, you could lose thousands, tens of thousands, or even hundreds of thousands to taxes and lost deferred growth opportunity.

2.) The 5 Year Method
You take distribtutions over the course of 5 years. You pay taxes on what is distributed each year. You pay no 10% Early Withdrawal Penalty. You get to enjoyed deferred growth for 5 years. And you can designate a beneficiary should something happen to you over the course of those 5 years.

3.) The Life Expectancy Method
This is probably the best option for most. Normally, at 70 1/2 an IRA holder has to start taking out what are called Required Minimum Distributions (RMDs) from their accounts because Uncle Sam is done waiting for his cut. The amount of the RMD is based on the account holder’s life expectancy. So, if at 70 1/2, there is a life expectancy of 20 years, then that year’s RMD will be 1/20th of the value of the account. However, in an Inherited IRA situation, the life expectancy of the bneneficiary is used. So, let us say that the beneficiary is 30 years old and we will use the same life expectancy of 90 (it is probably longer, but just go with it). Now the RMD is 1/60th of the value.

This would be a much smaller number on a year to year basis. This would mean lower taxes on the inheritance each year and a much larger period of time for tax deferred growth. This allows for a larger nest egg at retirement for the beneficiary of the inherited IRA. Additionally, since the beneficiary of an Inherited IRA can name their own beneficiary, it creates the opportunity for legacy and lasting wealth.

Again, the benefits of an Inherited IRA are:
– Required Minimum Distributions allowing for cash flow for the life of the beneficiary.
– No Early Withdrawal Penalty for RMDs while the beneficiary is under 59 1/2.
– Tax Deferred Growth on assets ongoing. A high probability (depending on the age of beneficiary at inheritance) that the Inherited IRA could be worth more at 70 1/2 than it was at inheritance even after RMDs.
– The ability to designate a beneficiary thus having the opportunity to create legacy.

But none of this can happen if not done properly.

The account has to be titled correctly. Your financial professional (I can do this) should be able to help with this.

Again, doing this correctly can add tens, if not hundreds, of thousands of dollars to the inheritance over time….(read more)

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