IRAs are complicated enough.    Inherited IRAs can even be more complicated, if not handled properly.

Be sure to find a good financial adviser who has experience with inherited IRAs, because they are handled differently than other investments such as 401k’s or life insurance policies.   Then make sure your beneficiaries understand what to do with an inherited IRA; you won’t be around to explain it to them.

Like most people you always working closely with your accountant to find ways to avoid unnecessary taxes.  You surely want to give your beneficiaries that same advantage.  If your heirs get bad advice, they will end up paying a lot of unnecessary taxes.

The Taxation Of Inherited IRAs

Help your heirs avoid extra taxes

Spousal Beneficiaries:

  • When a surviving spouse inherits your IRA, they can do an IRA rollover.
  • The surviving spouse can roll over the inherited IRA into a new IRA in their name.
  • This rollover option allows them to start a new minimum distribution schedule.
  • This new required minimum distribution schedule will be based on their age.
  • The surviving spouse will also be able to name new beneficiaries.

Non-Spousal Beneficiaries:

  • Inherited IRAs and TaxesIf the beneficiary of the inherited IRA is a non-spouse, such as your children, the inherited IRA is fully taxable immediately if they roll it over to their own personal IRAs.
  • The IRS views the rollover of an inherited IRA into an existing IRA as a distribution.
  • Distributions from IRAs are fully taxed, immediately, inherited IRAs are no different.
  • In addition to paying income taxes, the non-spouse beneficiaries may also be charged additional penalty taxes for each year that inherited IRA roll over money sits in their personal IRA account.
  • To avoid immediate taxation, the inherited IRA should not be rolled over into an existing IRA.
  • If the inherited IRA is rolled over to a new separate IRA account and retitled, the non-spouse beneficiary will only have to pay income taxes.

The Best Method To Take The IRA Balance

Lump Sum

  • If your beneficiaries take the entire balance of the inherited IRA as a lump sum, they will pay income taxes on the entire balance.

Distribution

  • If your heirs take the balance of the inherited IRA as a distribution, they will only be taxed on the distribution as they take it.
  • The distribution method vs the lump sum method will save them money in taxes.
  • With the distribution method the IRA investment will grow tax deferred.
  • Your heirs will have to take required minimum distributions at a certain point.
  • If they fail to take the required minimum distribution, they will pay penalties.
  • Just make sure they are aware of the RMD.

You want the best for your family.   You are giving them the best by helping them keep more of your money and paying less in taxes by teaching them what to do with an inherited IRA.