According to Forbes Online, the largest private transfer of wealth will take place over the next 30 – 40 years as members of the Baby Boomer generation pass their wealth on to younger generations. Some estimates are that $30 trillion will change hands. A large portion of that wealth is held in tax deferred or tax free IRAs (traditional and Roth and other tax deferred retirement accounts. If you inherit an IRA, and aren’t the surviving spouse, there are major rule differences that you must heed.
First, the rules that govern distributions from an inherited IRA will differ depending upon the beneficiary’s classification. If the account owner died after December 31, 2019, only an “eligible designated beneficiary” may take distributions from an inherited IRA over her remaining life expectancy. Individuals who are “eligible designated beneficiaries” under the tax code are: a surviving spouse; a minor child; a disabled individual; a chronically ill individual; or an individual not more than 10 years younger than the deceased account owner. If you do not fall into one of those categories, you are deemed to be a “designated beneficiary,” and you must liquidate the entire balance of the inherited IRA (traditional or Roth) within 10 years of the year of the account owner’s death.
As a designated beneficiary, you are not required to take periodic distributions (such as an annually) from the account. The tax code merely requires that all of the money be withdrawn by December 31 of the 10th year following the year of the account owner’s death. You can wait until the very end of the liquidation window before withdrawing the balance of the account. But remember, if the account is a traditional IRA, distributions will be taxable income to you, so it may make sense to take periodic distributions to reduce the income tax bite. Distributions from an inherited Roth IRA are not income taxable.
Second, you cannot roll over an inherited IRA like you can your own account. While you inherited the account, you are not considered the account owner under the tax code. That is why the deceased owner’s name must be on the account title “for the benefit of” the beneficiary. If you do try to roll a traditional IRA over into an account in your own name, you have made an irreversible taxable distribution! So too with an inherited Roth IRA. While the distribution may not taxable, it cannot be reversed. All the potential future tax-free growth will be lost.
However, you may directly transfer an inherited IRA from one custodian to another. In this type of transfer, the account balance is sent directly from the old custodian to the new one. Caution! – You cannot directly transfer money from an inherited IRA to your own IRA in hopes of avoiding the rollover prohibition. The IRS will consider that to be an irreversible distribution as well.
Third, you cannot contribute to your inherited IRA. If you would like to put money away for your retirement, you will have to open your own IRA.
Fourth, if you are under age 59½, the 10% early withdrawal penalty will not apply to distributions from your inherited IRA. The rule does not apply to forced distributions from an inherited account.
Finally, you cannot convert your inherited traditional IRA to a Roth. Not only is this deemed to be an irreversible taxable distribution, but the funds cannot then be deposited into a tax-free Roth account. Any future earnings on the remaining balance will be subject to taxation.
If you are struggling to manage your inherited IRA, give me a call. I can help.