What to Know About Inheriting an IRA

Losing a family member is difficult, and when it happens, the last thing on your mind is what to do with his or her retirement accounts. But, if you’re a beneficiary, just know that at some point you’ll need to make some decisions. And making the wrong moves could cost you in taxes and penalties. So here are some things to know.

First, if you’re a surviving spouse, you have some different rules and a bit more flexibility. Typically you can either transfer the assets to your own IRA, making you the new owner, or an inherited IRA, where it’s still in the decedent’s name. Keep in mind that if you make yourself the new owner and you’re under age 59½ and need the money, you’ll pay a 10% early withdrawal penalty.

For non-spouses, the rules are different and more complicated.

For example, you cannot distribute funds from an inherited IRA directly into your own IRA. That’s like getting a check payable to you, and it’s a taxable distribution. You also can’t do a 60-day rollover or Roth conversion with inherited IRA funds.

On the other hand, there is no 10% early withdrawal penalty on an inherited IRA. You’ll be taxed on the funds (unless it’s a Roth), but you’ll receive no penalty.

You’ll also have a required minimum distribution (RMD) on that inherited IRA, even if you’re nowhere near age 70½ (this includes Roth IRAs).

Now here’s where it gets a little bit complicated.

If the person who died did NOT yet have an RMD, then you as the non-spouse beneficiary have two options: take an RMD every year based on your life expectancy and stretch it out over that period of years until it’s gone or distribute the entire IRA within five years. In this case, if you miss an RMD you must follow the five-year rule.

But if the person who died was of RMD age, you have no five-year option. You MUST take an RMD out every single year or pay the 50% penalty for missing it. Got that? We told you it was complicated!

You should also know that for every IRA beneficiary, you can always just take a lump sum of the assets in one big distribution. Sometimes this is the simplest option for non-spouse beneficiaries, and if the account is small then this might make more sense. But do know that this leads to tax consequences, so before you do it be sure to check with your financial advisor.

Yes, it’s complicated inheriting an IRA, but knowing these rules can make it a little bit easier and maybe—just maybe—a little less stressful.

Information presented should not be considered specific tax, legal, or investment advice. You should always seek counsel of the appropriate advisor prior to making any investment decision. All investments are subject to risk including the loss of principal. This material was gathered from sources believed to be reliable, however, its accuracy cannot be guaranteed.

IRA withdrawals will be taxed at ordinary income rates. Withdrawals prior to age 59½ may also be subject to a 10% penalty tax.

Roth IRA distributions of principal from a Roth IRA are tax-free; however, any earnings will be taxed at ordinary income rates and a 10% penalty tax will apply if withdrawn prior to age 59½ or within five years of the date the Roth IRA was established, whichever is longer.

This information is for educational purposes only and no tax payer shall use it for unlawful tax reporting.

No client or prospective client should assume that the information contained herein (or any component thereof) serves as the receipt of, or a substitute for, personalized advice from Lucia Capital Group, its investment adviser representatives, affiliates or any other investment professional.

Raymond J. Lucia Jr. is chairman of Lucia Capital Group, a registered investment advisor and CEO of its affiliated broker-dealer, Lucia Securities, LLC, member FINRA/SIPC. Advisory services offered through Lucia Capital Group. Securities offered through Lucia Securities, LLC. Registration with the SEC does not imply a certain level of skill or training.

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