Are you a beneficiary of a retirement account?
If you’re here, you may be in the process of inheriting an IRA retirement account from your parent or other loved one. Or maybe you’re wondering what it means to inherit an IRA and what your options will be in the future.
No matter what stage you’re in, it can be overwhelming to navigate the complexities of inherited retirement accounts. From understanding the tax implications to making smart investment decisions, you need the help of an experienced estate planning attorney to ensure your inheritance is beneficial instead of burdensome to you and your family.
At Your Legacy Legal Care™, we want to help ease the burden of figuring out the complexities of inherited retirement accounts so you can rest easy knowing your loved one’s legacy is honored, and your financial future is secured.
Inherited retirement accounts are financial accounts that pass from one person to another when the original account holder dies. Examples of these accounts include IRAs, 401(k)s, and pension plans.
In most cases, the beneficiary of the account will receive the assets and become the new owner of the account. Beneficiaries have a number of choices when it comes to distributing the funds in the account, many of which are subject to income tax and other penalties. This, of course, depends on the type of account and the person inheriting it.
When it comes to distributions on inherited IRAs, your options depend on your relationship with the deceased. The rules for taking distributions are different for certain types of beneficiaries, and knowing how your relationship affects your choices is crucial in order to plan ahead.
If you are the spouse of the IRA’s original owner and you are the account’s sole beneficiary, you’ll have different options for distributions than other types of beneficiaries—like adult children or even charitable organizations.
If you are not the spouse of the deceased individual, you are likely considered a “designated beneficiary.” This status includes adult children, unrelated individuals, and charitable organizations.
Federal law allows certain exceptions to inherited retirement account distribution rules for beneficiaries that fall into three categories:
Beneficiaries of IRAs are responsible for any taxes that may be due on the account. It’s crucial to understand which types of IRA accounts require beneficiaries to pay taxes and which do not. This can help you get a better picture of what your financial plan should be for the IRA funds.
Both traditional IRAs and simple IRAs are subject to taxes when the funds are withdrawn by the beneficiary because the assets in the retirement account were contributed pre-tax by the original owner of the account. The beneficiary may be required to pay income tax on the amount withdrawn, which is calculated based on the beneficiary’s individual tax bracket.
Inherited Roth IRAs are not subject to income tax when received by a beneficiary. This is because assets within the Roth IRA were contributed to the account post-tax by the original owner.
The age of death of an IRA owner can have an important impact on how distributions are made to the beneficiary. Knowing this information can help beneficiaries understand their options for receiving IRA funds.
The Required Beginning Date (RBD) of an IRA is the date at which the original owner of the account would have had to start taking the Required Minimum Distribution (RMD). This is often at 72 years of age.
If the account holder dies before the RBD and their spouse is the IRA’s sole beneficiary, the spouse has a few distribution options:
If the spouse of the deceased chooses the final option, they must take the RMD beginning the year after the account holder’s death or the year that the account holder would have turned 72, whichever is later.
Say the IRA account holder passes away after already beginning their required distributions, and the spouse is the sole beneficiary. The assets must then be distributed over either the life expectancy of the spouse or the life expectancy of the deceased, whichever is longer.
If the spouse’s life expectancy is used, the calculation is updated annually. But if the deceased’s life expectancy is chosen, the number is fixed the year they died and then reduced by one in the following years.
No matter which option is chosen, the spouse of the deceased is responsible for distributing the assets in the IRA account. This helps to ensure that the assets are properly taken care of and enjoyed for many years to come.
For non-spouse beneficiaries that do not qualify as “eligible designated beneficiaries,” the rules are a bit different than those sole beneficiaries that are the spouse of the original IRA account holder.
When it comes to non-spouse beneficiaries, the Secure Act has changed how retirement accounts are distributed. All assets must now be disbursed within 10 years instead of the life expectancy of the oldest beneficiary.
Spouses, those with disabilities, and minors are exempt from this 10-year rule. However, minors are subject to it once they reach majority age.
For those who choose to designate a non-person—such as an estate or a charity—as their retirement account beneficiary, the full balance must be distributed by the end of the fifth year following the year of the participant’s death.
Gaining an inheritance is a good thing. You can carry on the legacy of your lost loved one while you secure the financial future of both yourself and your family.
But the laws and regulations surrounding inherited retirement accounts can be overwhelming, and if there’s a mistake made, it could cost you a lot.
Getting help from an estate planning lawyer is essential when dealing with inherited IRA account funds. An experienced lawyer can help you understand the options available and the best way to manage the funds.
Your Legacy Legal Care™ will help ensure your family’s future is secure and your loved one’s wishes are honored. Contact us today to get started.
Kimberly Hegwood is the Managing Attorney of Your Legacy Legal Care, a Houston estate planning law firm. With more than 25 years of experience practicing law in Texas, she represents clients in a wide range of legal matters, including elder law, asset protection, estate planning, Medicaid crisis planning, probate, guardianship, and other estate planning practice areas.
Kimberly received her Juris Doctor from the South Texas College of Law and is a member of the State Bar of Texas.
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