Inheriting an IRA from someone who was not your spouse can feel like a financial gift — until you meet the maze of rules that come with it.
The IRS doesn’t exactly hand out user manuals, and one wrong move can shrink that inheritance faster than you can say “unforced tax error.” With a little strategy and a lot of restraint, nonspouse beneficiaries can avoid the biggest and most expensive mistakes.
Believe it or not, the smartest first step is to do absolutely nothing. Put the pen down, step away from the withdrawal button and resist the urge to make a quick move. Cashing out early without a plan can cause you to lose years of tax-favored growth.
Inherited IRA dollars are special: they can’t be mixed with your own retirement accounts, you can’t make new contributions to them and you can’t convert them into inherited Roth IRAs. Before touching a thing, get clarity on the rules and how they apply to your own financial situation. A qualified advisor can help you avoid turning a windfall into an accidental tax bomb.
Once you’ve taken a deep breath and resisted impulsive moves, your next step is to set up a properly titled inherited IRA. This step matters as the account must reference both you and the original owner to avoid tax trouble. If you’re not thrilled with the current financial institution, you can move the account but only through a trustee-to-trustee transfer.
Nonspouse beneficiaries are barred from doing a 60-day rollover, and attempting one will detonate the entire account as taxable income — not the kind of surprise anyone wants.
Things get trickier when the original IRA names multiple beneficiaries. In that case, it’s crucial to split the inherited IRA so each beneficiary receives their own separate account. Doing so ensures each person gets the longest payout period the rules allow. Keeping everything lumped together can shorten those timelines and compress tax obligations, essentially punishing you for not doing a little paperwork.
No matter how the account is set up, prepare yourself for required minimum distributions. Both traditional and Roth inherited IRAs come with withdrawal rules, and most nonspouse beneficiaries under the SECURE Act must empty the account within 10 years. Some must also take annual RMDs during that period. Miss an RMD, and the IRS pounces with a penalty — the financial equivalent of “Gotcha.”
Deadlines matter here, too. Inherited IRAs must be established and split, if needed, by Dec. 31 of the year after the original owner’s death. Ignore that date, and your payout options may vanish. It’s also worth checking the original owner’s records to see whether their traditional IRA included nondeductible contributions.
If so, part of your distributions may be tax-free, and you don’t want to overlook that gift. Finally, make sure you name beneficiaries on your newly established inherited IRA. Nothing derails a legacy faster than failing to protect the next link in the chain.
Inheriting an IRA may not come with an instruction booklet, but approaching it with patience, precision and a bit of skepticism about “easy buttons” can preserve its value — and your sanity.
Michelle Kuehner, a Chartered Financial Consultant and Master Certified Estate Planner, is the president of Personal Money Planning LLC, a Wichita Falls retirement planning and investment management firm.
This article originally appeared on San Angelo Standard-Times: Avoid turning your inherited IRA into an IRS tip jar | Opinion
Reporting by Michelle Kuehner, San Angelo Standard-Times / San Angelo Standard-Times
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