Inheriting an IRA from a loved one can be confusing and costly if you make a mistake.
Here are five things to keep in mind if you inherit IRA assets:
If you inherit an IRA, you may be tempted to spend the balance. If you cash out an inherited IRA, however, you will pay ordinary income taxes on the full amount of the inheritance.
If you don’t need the money all at once, you may be able to keep the IRA alive for ten years. During that time, the money you leave in the IRA can keep growing without being taxed until you withdraw the funds.
Here’s where using common sense could get you into trouble. Once you inherit an IRA, you may assume that the account is yours. That’s true, but you need to maintain its status as an Inherited IRA account. Only a spouse can treat inherited IRA assets as his or her own by putting the account in his or her name. If any other beneficiary puts his or her own name on an IRA inherited from anyone other than a spouse, the Internal Revenue Service will consider this innocent act a cash out of the IRA, and he or she will owe taxes on the windfall.
How can you protect against this nightmare scenario but still claim what is rightfully yours? Make sure the new account title includes the original IRA owner’s name or the term “Inherited IRA.”
Don’t ever forget that an inherited IRA has its own unique rules. One of those rules dictates that you can never contribute money to this account. If you add money to an inherited IRA, all the assets in the account become subject to income taxes. That means bye, bye IRA.
While it’s admirable to want to preserve the IRA, as a beneficiary, you must make withdrawals. With the new SECURE Act, most non-spouse beneficiaries have 10 years to withdraw all the funds. It’s up to you to figure out how much you want to take in each of the 10 years, but you have to take all the withdrawals by end of the 10th year. Taxes definitely play into this decision, so talk to your financial advisor and/or tax professional about what’s best for you.
After you inherit an IRA, get a professional opinion on how to proceed. IRA inheritance rules can be tricky, and you don’t want to make an irrevocable mistake.