Inheritance Taxes? I Don’t Have To Worry About Inheritance Taxes!
You may think you don’t have any cause for concern when it comes to the complicated mess of inheritance taxes, but you’d be surprised. There are taxes and then there are inheritance taxes. Most people do not think that they will ever have to worry about inheritance tax issues. They think this way because they do not make a lot of money, do not have a lot of assets or they are loaded with debt. This is a financial fallacy and your miscalculation could turn out to be expensive. Many unprepared taxpayers will regret the day they thought that their lower-income base, assets or debt troubles would keep them free and clear of inheritance taxes. But believe it or not, your debt, income base or amount of assets has little to do with avoiding inheritance taxes on money coming from Individual Retirement Accounts.
Money inherited from Individual Retirement Accounts (IRA’s) is handled differently in regards to taxation. When it comes to the taxation of IRA’s at inheritance time, it can get a bit complicated if some preplanning was not done. If you will be inheriting money from an IRA you do not want to be caught off guard. If you will be passing your IRA money onto your heirs, save some money, don’t be caught off guard. And the best way to avoid being caught off guard with an inheritance tax problem is to learn some key rules.
Rule #1 – Check Your Designated Beneficiaries
Unfortunately, many people believe that once they get their will set up they have completed their estate planning. They assume that their will determines who inherits everything they own, so there is no need to go any further. That assumption is incorrect. For starters, a will only applies to certain types of property. Real estate property that is not held in joint tenancy can be passed on through a will. But bank accounts with a Payable On Death (POD) designation do not go through a will. And life insurance or investments (like your IRA) with a designated beneficiary on file do not go through a will. Therefore it is extremely important to pay close attention to beneficiaries listed on your investment accounts. The beneficiary designation form held by the IRA custodian, not a will, determines who inherits and then pays inheritance taxes on an IRA.
Always remember to be certain that your beneficiaries are in order. Be sure that a beneficiary is recorded, listed or on file with the IRA custodian. If you forget to name a beneficiary, at the time of your death your beneficiaries may have to deal with probate. If your loved ones cannot find who the beneficiaries should be, dealing with your investments will cause them problems. So keep your beneficiaries in a place where your loved ones can find them. Many times after a beneficiary dies a replacement one is not named, so be sure to keep your beneficiaries current.
Rule #2 – Non-spouses Beware
If a non spouse inherits your IRA money, it is a very bad idea for them to roll it over into their own IRAs. By doing that, they subject the entire inherited IRA to be hit with inheritance taxes. This is because the IRS views this rollover from a non-spouse as a distribution. And distributions are always taxed.
To avoid this expensive mistake, any non-spouses who inherit an IRA has two options. One, they can have the money stretched out over their life expectancy. Whenever possible this is the better of the two options. With the stretch-IRA option, the money stays in the IRA untouched by taxes, growing tax-free for as long as possible. The second option is the 5-year rule. Under this option the money is paid out within 5 years of the original owner’s death. If there are any issues with the beneficiary forms, such as incomplete, nonexistence or ambiguous, the heir will be forced to use the 5 year option.
Rule #3 – Spouses Are A-Okay
Surviving spouses can rollover an inherited IRA into a new IRA in their own name. A spouse can then name new beneficiaries and start a new required minimum distribution schedule that would be based on their own age. If the surviving spouse does not roll the inherited IRA into a new IRA, the required distributions will begin shortly after the IRA is inherited.
Your Inheritance, Your Problem?
Unfortunately, many financial institutions such as banks or insurance agents are unfamiliar with the finite details of IRA inheritance tax issues. Many simply ask you what you want to do with your newly inherited money. This leads you wide open with little regard to tax consequences.
Bankers or insurance agents are not necessarily tax advisers so are not familiar with all of the tax rules. Your best move is to learn as much as you can about IRA’s and the tax issues involved before you inherit one. In addition, seek the advice of a financial adviser who specializes in IRA’s, stretch IRA’s, the 5-year rule and inheritance taxes. If you are unsure, ask your accountant for a referral, and interview at least 3 advisors before selecting one. Making the wrong choice could be a very expensive financial move, so choose wisely.