We know IRAs come with their own set of rules–minimum age for withdrawals, required minimum distributions after a certain age, taxes, and penalties to enforce them. But what happens when you inherit an IRA? Turns out, inherited IRAs come with their own set of rules, and if you aren’t aware of them, it could cost you big.
Different Rules For Different People
Generally, there are two different sets of rules for those who inherit IRAs. Spouses follow one set, while all other inheritors follow different guidelines.
Say you inherited an IRA from your spouse. You can roll it over into a new IRA or rename it as your own. As your IRA, you will be subject to the same rules. No withdrawals until you’re 59 ½ and RMDs starting at 70 ½, remembering there is a 10% penalty for withdrawing early and a 50% penalty for missing RMDs.
If you want an immediate access you also have the option to turn the account into an inherited IRA. Under this route, you will have to begin taking out RMDs based on your life expectancy, however, every withdrawal will be taxed at ordinary income.
What if I Get an IRA Not From My Spouse?
If you get an IRA from anyone other than a spouse, you cannot roll it over or put it in your own name.
You will have a few options, and you have to carefully consider the costs of each one.
First off, you may take a lump sum. While it is tempting to have all of it at once, you must remember it comes with tax at ordinary income rate, pushing you up the marginal tax bracket. An IRA of $100,000 can be taxed up to 28%.
If you don’t want the lump sum, you can have it paid out to you, but this must be done within five years. And again, every withdrawal will be taxed.
Your final option is to make it an inherited IRA, like spouses can. You will have to follow a life expectancy table which tells you your RMD for each year, which will be taxed. However, because the IRA is preserved over time, it can continue to grow, giving you a longer stream of income.
Can I avoid being taxed?
No. Not really. You can only choose the time at which you withdraw from it, but any withdrawal will be taxed, and there are penalties for not withdrawing on time. Because of this, it is best to discuss your options with a financial advisor you trust. Not all options are equally as good for everyone, and you will want to consider the tax loads and penalties associated with all outcomes.