Some assets, such as cash, are simple to pass on to heirs. Other assets, such as IRAs, have certain rules and conditions that change depending on the distribution method chosen and the relationship of the beneficiary.
There are two main categories of IRA beneficiary: spousal and non-spousal. Today, let’s review the choices for each.
Non-Spousal Options
Lump sum distribution
With a lump-sum distribution, all the assets in the deceased individual’s IRA are immediately dispersed to the beneficiary. The beneficiary is left with no further IRA assets and will be taxed on the full amount of the distribution. The amount of the full distribution is added to all of their other income for that year and will be taxed according to their federal and state tax bracket.
Transfer to an inherited IRA
With an inherited IRA, the beneficiary moves assets into a new account that allows them to take penalty-free distributions. The beneficiary must begin taking distributions called Required Minimum Distributions (RMD) based on their age and life expectancy. The IRS has a formula for calculating the amount. This allows the beneficiary to spread the tax liability out over their lifetime as they are only taxed on the amount they withdraw each year, and not on the remaining balance. An inherited IRA account must be established and distributions must start by December 31st of the year following the deceased owner’s date of death. If it is not established within this time frame, the account must be distributed fully within five years.
5-year rule
If RMD distributions have not been established by December 31st of the year following the date of death, then the entire account balance must be distributed by the fifth anniversary of the date of death. Discretionary withdrawals can be taken at any point within the first five years, but any balance remaining on the fifth anniversary will be distributed to the beneficiary and fully taxable.
No money can be added to an Inherited IRA or decedent’s IRA, nor can it be commingled with other IRAs owned by the beneficiary.
Spousal options
Spouses can choose from all the options above, but they also have one additional choice. They can treat the IRA as their own with a spousal transfer. This moves the inherited IRA assets over to the IRA of the spouse and it means that the penalties for early withdrawal will apply if the surviving spouse is under age 59½. They do not have to take RMDs until they reach 70½.
At Kramer Wealth Managers, we can help review all your options and determine which one makes the most tax- and income-efficient choice. Contact us today to get started.
While the tax or legal information provided is based on our understanding of current laws, this information is not intended as tax or legal advice. Federal tax laws are complex and subject to change. Neither Osaic Wealth nor its registered representatives, provide tax or legal advice. As with all matters of a tax or legal nature, you should consult with your tax or legal counsel for advice.
