Summary
Learn your options with a spousal inherited IRA and a non-spousal inherited IRA and understand the important differences between them.
Learn the Various Options Available to You
When an individual passes away, their retirement savings plan can be transferred to their beneficiaries in the form of an inherited IRA. An IRA is an Individual Retirement Account, and it allows individuals to save for retirement while enjoying tax benefits. A beneficiary for an inherited IRA can be a spouse, child, or other designated person. If you have inherited an IRA from a loved one, there are several things you should know to help make the most of this inheritance, so read on to learn more.
Types of IRAs
The first thing to understand is that there are two types of inherited IRA accounts: Traditional and Roth. A Traditional IRA is a tax-deferred retirement savings plan, which means that the contributions are tax-deductible, and the withdrawals are taxable. A Roth IRA is also a retirement savings plan, however the contributions are made after-tax, making the subsequent withdrawals tax-free.
Inherited IRA Rules to Know
The rules for inheriting an IRA depend on whether you are the spouse or non-spouse of the deceased account owner. If you are the spouse of the deceased account owner, then you have a “spousal inherited IRA.” If you are a non-spouse beneficiary of an inherited IRA, then you have a “non-spousal inherited IRA.”
SEE ALSO: The Importance of Estate Planning at Any Adult Phase of Life
Let’s review the options for both:
Spousal Inherited IRA
Spouses who have inherited an IRA typically have more flexibility and options than in the case of a non-spouse. Although there are a few exceptions, there are generally four paths that inherited IRA rules allow you to take with a spousal inherited IRA:
- You can move the money to an IRA in your own name, and it will be treated as if it was in your name all along. You can continue to contribute to the IRA, and you won’t need to worry about taking Required Minimum Distributions (RMDs) until you turn 73. You will face a penalty for withdrawing funds before age 59 ½.
- You can choose to open an “Inherited IRA” and elect to take annual, taxable distributions over your life expectancy. If you’re under age 59 ½, you can use this option to access cash to pay bills and expenses without the standard early withdrawal penalty.
- You can choose to open an “Inherited IRA” and elect to take distributions over 10 years. You’ll need to distribute all the assets in the IRA – and pay taxes on them – within that timeframe.
- You can also cash out an inherited IRA and move the cash to a savings account, a brokerage account, or another type of financial account that suits your needs. However, this can create a significant tax liability all at once (rather than distributed over a period of years, as with several of the other options).
Determining the best option for you can be complex – and there are a few exceptions to the above options, too – so be sure to talk with a financial advisor about your spousal inherited IRA and the option most suitable for your unique situation.
SEE ALSO: 8 Reasons Why You Should NOT Make a DIY Financial Plan
Non-Spousal Inherited IRA
The rules surrounding the inherited IRA for non-spouses were amended as of January 1, 2020, and they can be a bit tricky. So, if you are reading this and you inherited an IRA before this date, know that the old rules will apply. Below, we will discuss the new rules for a non-spousal inherited IRA and how they impact you if you are a non-spouse inherited IRA beneficiary.
First, you won’t have the same options as a spouse who inherits an IRA. You’ll also have to abide by the “10-year rule.” This is a new regulation that states that if you inherited an IRA from your parents, a grandparent, or anyone else who was not your spouse, you only have 10 years to distribute the entire IRA. This applies to both Traditional and Roth IRAs, and it represents a significant change because it removes the “stretch IRA” option. Under the old rules for a non-spousal inherited IRA, you could stretch those distributions either over a five-year period or for the rest of your life. With that flexibility gone, you must now fully distribute the money in 10 years or less.
This is a significant change because of the tax consequences. Here are your options:
- Take out all the money at once
- Take distributions evenly over 10 years
- Take more in one year versus other years
If you inherited an IRA from someone who was taking out RMDs, you would need to take out RMDs during those 10 years, too. As with a spousal inherited IRA, it’s often helpful to develop a strategy with your financial advisor so that you can choose the path that best suits your financial circumstances, especially since there are several exceptions to the 10-year rule.
Do You Need Help Navigating Inherited IRA Rules?
Inheriting an IRA usually means you’ve lost someone close to you, and it can be difficult to navigate grief and financial decision-making at the same time. If you’d like assistance in developing a strategy for your inherited IRA, we can help. At Aviance, we take the time to understand your personal financial circumstances, and we can assist you in building a wealth management plan that helps you meet your goals. If you have questions or you’d like to learn more about our services, please schedule a call with us today.
Aviance Capital Partners, LLC (“ACP”) is an SEC registered investment adviser located in Naples, Florida. Registration as an investment adviser is not an endorsement by securities regulators and does not imply that ACP has attained a certain level of skill, training, or ability. While information presented is believed to be factual and up-to-date, ACP does not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change. Not all services will be appropriate or necessary for all clients, and the potential value and benefit of the ACP’s services will vary based upon the client’s individual investment, financial, and tax circumstances. The effectiveness and potential success of a financial plan depends on a variety of factors, including but not limited to the manner and timing of implementation, coordination with the client and the client’s other engaged professionals, and market conditions. The tax and estate planning information provided is general in nature, which should not be construed as specific financial planning or tax advice tailored to an individual reader. ACP suggests that readers consult a financial professional, attorney or tax advisory professional about their specific financial, legal or tax situation. Customized financial planning indicates that financial planning will be informed by the material financial and investment circumstances of the client, as communicated by the client to the adviser, but may not consider literally all aspects of a client’s financial affairs. Past investment performance does not guarantee future results. All investment strategies have the potential for profit or loss, and different investments and types of investments involve varying degrees of risk. There can be no assurance that the future performance of any specific investment or investment strategy, including those undertaken or recommended by ACP, will be profitable or equal any historical performance level. Additional information about ACP, including its Form ADV Part 2A describing its services, fees, and applicable conflicts of interest and its Form CRS is available upon request and at https://adviserinfo.sec.gov/firm/summary/146597.
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