I was recently asked to provide advice for the New York Daily News Money Pros column, and I felt that the topic was so important that it would be great to share it with you too. Inheriting an IRA can be confusing to even the savviest investor and the implications for your financial planning and tax situations can be enormous. You can read the original column here at the New York Daily News, or check out an expanded version below.
What To Do
Receiving an IRA as an inheritance can feel like winning the lottery with the same temptations to spend the money right away. However, this can lead to some big financial planning mistakes. Each situation can be very different, so before you take action, it is prudent to seek professional financial help to guide you through the estate planning and tax planning consequences of inheriting an IRA.
That being said, there are a few important things to consider when inheriting an IRA. The most important are 1) whether or not you’ve inherited the account from a spouse, 2) the potential benefits of keeping the account around longer, and 3) your current and future tax bracket.
Those who inherit an IRA from someone other than their spouse have a choice between cashing out the account as a lump sum, liquidating the account within 5 years, or stretching the required distributions over their own life expectancy. Note that stretch distributions must begin in the calendar year after the deceased’s death. Spouses who inherit IRAs also have one other option: They can roll over the assets into their own IRA if they choose, meaning that required distributions would not be mandated until he or she reaches 70 ½ years of age.
The key potential benefit to stretching distributions is that any earnings in the account will grow tax-deferred over your lifetime. You also have the flexibility to take more than the minimum distribution if you need it. On the other hand, the more you draw down the account in the short run, the less you’ll have for potential growth or to meet future needs (i.e. – to fund your retirement, help your children or grandchildren pay for college, or buy a vacation home). For more detailed information you can refer to the Internal Revenue Publication 590.
Another benefit to the stretch option is that the distributions will have a smaller effect on your annual tax bill. If you’re in a high tax bracket, this can be a powerful incentive to stick with the stretch option. On the other hand, if the account you inherited is very small and you need the money, it might make sense to liquidate it over a shorter period if it won’t have a major effect on your tax rate.
There are also local tax laws that you’ll want to take into account. Consider that for New York State residents, if the deceased was over 59 ½, withdrawals for the beneficiary would be subject to federal taxes. However, the first $20,000 withdrawn each year would be exempt from state taxes. Most New Yorkers would want to take this into consideration, especially with a larger account.
With all that being said, you might see why it generally makes sense to roll an inherited account into your own IRA if you inherit from a spouse and why it’s often best to stretch the distributions over your life expectancy if you inherit from someone other than your spouse. I want to reiterate that each situation is different so I would strongly recommend getting the help of an independent financial advisor or Certified Public Accountant (CPA) experienced in handling inherited IRAs before making any decisions or withdrawals.
Keep in mind that the most important thing is not to procrastinate when figuring out what the best course of action will be for you. If you choose the stretch option, you’ll be required to take your first distribution in the calendar year following the original account-holder’s death, and you also need to make sure that the account-holder took any required minimum distributions in the year in which they passed away. Failing to take these steps could have a major impact on your tax planning so remember to ask your advisor about it.
Bradford Pine is a wealth advisor in Garden City, NY and president of the Bradford Pine Wealth Group. www.BradfordPineWealth.com
Cantella & Co., Inc. & Bradford Pine do not provide legal or tax advice. For legal or tax advice, please seek the services of a qualified professional. This material is not intended to provide legal, tax or investment advice, or to avoid penalties that may be imposed under U.S. Federal tax laws, nor is it intended as a complete discussion of the tax and legal issues surrounding retirement investing. You should contact your tax advisor to learn more about the rules that may affect individual situations. Securities offered through Cantella & Co., Inc. Member FINRA/SIPC.
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Written by Bradford Pine
Bradford Pine Wealth Group – New York City Financial Advisors
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