WHAT SHOULD I DO WITH MY INHERITED IRA?
As employer pension plans go the way of the dodo bird and social security becomes less secure, we are seeing more and more of our clients have planning for their retirement with individual retirement accounts (IRAs). In fact, it is becoming common for IRAs to make up a significant percentage of a client’s total assets, especially when he or she is at or near retirement age. Because so much wealth is likely to be passed to the next generation through IRAs, it is important for IRA owners and potential beneficiaries to know how to get the most out of inherited IRAs.
In a traditional IRA, the money you put in is allowed to grow tax-deferred (you don’t pay taxes on gains as they are incurred). However, at a certain age (70 ½), you will be required to start taking distributions in an amount that is based on your life expectancy. You will pay income tax on these required minimum distributions (or any other distributions you choose to take).
If you leave your IRA to your spouse, the account can “roll over” into your spouse’s name. This means that the required minimum distributions will be based on your spouse’s (hopefully longer) life expectancy, allowing for a longer deferral of taxes (often called a “stretch out”). Your spouse can name younger beneficiaries to take over the IRA next, producing an even longer stretch out.
What if you leave your IRA to someone other than your spouse? The rules change a little; no “roll over” is allowed. An individual beneficiary can either cash out the IRA or retitle the account. While cashing out may be tempting, it will result in immediate tax consequences. The alternative is to stretch out the distribution schedule (and thus the tax-deferred growth) of the IRA by changing the title so that required minimum distributions will be based on the beneficiary’s life expectancy.
If you’re thinking this sounds complicated, don’t worry; you also can take advantage of IRA stretch out opportunities through proper trust planning. For more information, call us to set up a free estate planning consultation or see How to Handle Inherited IRAs by Jane Bryant Quinn: http://www.aarp.org/money/investing/info-10-2012/how-to-handle-inherited-iras.html