Traditional individual retirement accounts (IRAs) became available in 1974 and have been around ever since. This makes your odds of inheriting a traditional IRA pretty good.
The purpose of this letter is to look at some of the rules that apply when you inherit an IRA from someone other than your spouse.
Traditional IRA Inherited from a Non-spouse
Death after start date. If you inherit an IRA from an owner who dies upon attaining age 70 1/2 or later, the IRA must distribute any assets that remain to you (the beneficiary) over the longer of your expected life span or the deceased owner’s expected life span (before death).
With the exception of separate accounts, if there is more than one beneficiary, the rule requires distribution of the deceased owner’s traditional IRA over the longer designated beneficiary’s life expectancy or the owner’s life expectancy. For this tax rule, the beneficiary with the shortest life expectancy (usually the oldest person) is the designated beneficiary.
If the owner divided the IRA into separate accounts for the beneficiaries, the accounts act as separate IRAs for distribution purposes.
Death before start date. If the owner dies before his or her required start date (age 70 1/2), the IRA must distribute any remaining assets under either
- the five-year rule, which requires that the IRA distribute the assets within five years after the death of the owner, or
- the life expectancy rule, which requires that all remaining assets be distributed over the life span of the designated beneficiary.
As you receive the monies from the inherited traditional IRA, you pay taxes at ordinary income rates.
To minimize taxes for your beneficiaries, aim to stretch out the distributions for as long as possible. This makes the five-year plan rarely a good idea. But it does shine the light on youth. The younger the surviving beneficiaries, the more stretch you create.
By stretching out non-spouse inherited IRA distributions for as long as possible, you can turn a potential tax danger into a tax benefit. IRA stretching is a proven and widely used method in estate planning. It also allows the IRA’s assets to continue to grow tax-deferred, so with wise investments you could create your own legacy.
You likely need to know the basic rules that apply to inherited IRAs because you have high odds of both inheriting a traditional IRA and leaving one to your named beneficiaries.
If you would like to discuss IRAs in more detail, simply give me a call.
Robert W Craig, EA Tax Services
431 2nd Street, Suite 3, Solvang, CA, 93463