Do you want to hand your heirs big tax problems? Would you like to hand the IRS a sizable chunk of your wealth? Probably not. But if you misunderstand the rules when it comes to inherited IRAs, you just might. Here are some missteps that IRA owners and IRA heirs often make \u2013 financial choices you might come to regret.<\/p>\n
Thinking that a will or a trust can facilitate the transfer of IRA assets.<\/strong> Most IRAs don\u2019t pass to heirs through wills or trusts (a few rare exceptions aside). The beneficiary form takes precedence \u2013 the form the IRA owner filled out and signed when opening the account. Problems arise when<\/p>\n In these circumstances, IRA heirs commonly end up playing by the IRA custodian\u2019s rules. The resulting beneficiary may be the IRA owner\u2019s estate \u2013 a very undesirable tax consequence. It might be a contingent beneficiary \u2013 perhaps a very undesirable emotional consequence. The lesson here is to keep the beneficiary form handy and to let your heirs know where it is.<\/p>\n <\/strong><\/p>\n Taking lump-sum distributions.<\/strong> Too often, non-spousal IRA heirs see the inherited assets as money to spend. They withdraw the entire IRA balance in one fell swoop. Bad idea: all that money will be subject to federal income tax. Due to this move, they may lose a third of the IRA assets (or more).<\/p>\n The alternatives? Non-spousal beneficiaries can open an inherited Roth or traditional IRA and simply take Required Minimum Distributions (RMDs) from that inherited IRA under the appropriate schedule:<\/p>\n This decision can allow the invested IRA assets to keep compounding with the added benefit of tax deferral.<\/p>\n <\/strong><\/p>\n Not realizing your four options when you inherit your spouse\u2019s IRA.<\/strong> If a spouse dies, the surviving spouse that inherits an IRA has some choices. He or she can:<\/p>\n There are compelling reasons to go with the rollover. The widowed spouse can set up an RMD schedule based on his or her life expectancy. This second point is really important, because the rollover allows the surviving spouse to put off the RMDs that would otherwise soon need to happen. In fact, the surviving spouse can wait until the year in which the original IRA owner would have turned 70\u00bd to start taking required withdrawals from the IRA.<\/p>\n But there is also a compelling tax reason\u00a0not<\/em> to make a rollover if the widowed spouse wants to take distributions from the inherited IRA before age 59\u00bd. If that is the desire, those withdrawals will be slapped with the nagging 10% early withdrawal penalty plus the requisite income taxes.<\/p>\n If the spouse converts the IRA into his or her own IRA, the surviving spouse can name a beneficiary for the inherited assets, keep contributing to the IRA, and potentially avoid RMDs until he or she turns 70\u00bd.<\/p>\n <\/sup><\/p>\n Alternately, a surviving spouse who doesn\u2019t really need inherited IRA assets can \u201cdisclaim\u201d them, meaning that they will go to a contingent beneficiary. Sometimes this can be a wise move for tax purposes.<\/p>\n <\/sup><\/p>\n Non-spousal heirs fail to retitle an inherited IRA.<\/strong> If this isn\u2019t done in the year following the year in which the original IRA owner passed, then there can be no direct rollover of the inherited IRA assets and no \u201cstretch\u201d for those assets.<\/p>\n What happens if a non-spouse beneficiary just rolls the inherited IRA assets into an IRA they own, one that isn\u2019t retitled? Then it is not a direct rollover. The IRS treats those inherited IRA assets like a fully taxable cash distribution \u2013 100% of it is subject to income tax.<\/p>\n Ask for help, and don\u2019t be afraid to ask questions.<\/strong> Many families and couples have only a hazy understanding of the rules governing IRAs, and few really know all the options. Make sure your IRA beneficiary form is up to date, and speak with the financial professional you know and trust about how to handle the transfer of IRA assets when the time comes.<\/p>\n","protected":false},"excerpt":{"rendered":" Do you want to hand your heirs big tax problems? Would you like to hand the IRS a sizable chunk of your wealth? Probably not. But if you misunderstand the rules when it comes to inherited IRAs, you just might. 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