If you are the beneficiary but not the spouse of the account owner for a Traditional IRA, you probably have more inheritance options than you might think. It’s not uncommon for beneficiaries to misunderstand their options and cash out their new-found inherited IRA only to land themselves with a massive income tax bill. The best way to combat this is to know your options and choose accordingly. In this article, we will go over options available to you by understanding the non-spouse beneficiary IRA rules of a Traditional IRA.
Beneficiary IRA Rules
Below is a list of 4 options that will help you decide what you should do with your Traditional Inherited IRA. But before diving into the beneficiary IRA rules, you should know three important things:
- There is NO option to simply roll your newly inherited IRA into your current IRA.
- Normally, there is a 10% withdrawal penalty for early distribution withdrawals. However, in this case, you are able to take these deductions without that penalty.
- While we are discussing four possible options in this article, we caution against using these four options as a fail-safe roadmap. There are special cases and exceptions. For example, in the event that a spouse is still alive but is not the beneficiary, there may be special circumstances. Depending on the age of the original account owner at their time of death, there may be special circumstances. Therefore, it is always important to consult the IRA custodian of unique options on a case-by-case basis.
4 Options For Non-Spousal IRA Beneficiaries
1. Cash-Out the IRA Over 5 Years
A non-spouse IRA beneficiary may withdraw all IRA funds by December 31st of the 5th year after the death of the account owner. If you select this option, any payout (in the year in which the funds are withdrawn) will be included in your taxable income. The distributions can, but do not need to be taken out in installments. However, if this is how you do want to take out the distributions, all distributions must be taken before the end of the 5 year period following the account owner’s death.
2. Eliminate The Minimum Distributions Required For Your Own Life Expectancy
If you are considerably younger than the IRA account owner was, this option may help you build up a nice nest egg. A possibility may be for you to take out the required minimum distributions (as the non-spouse IRA beneficiary) but leave the majority of the account to build over time, tax-deferred. This is also often called a “Stretch IRA.” Similar to option 1, any distribution you take out will be taxable income for the year in which the funds were withdrawn.
If this option interests you, you will need to establish a different inherited IRA in the name of the deceased account owner for your own benefit. You must also take the first deduction by December 31st of the year following the death of the original account owner. As an example the name would be something like: “John Smith, IRA (died 2/3/18), FBO Jane Doe, beneficiary.” From this you are also able to add your own beneficiaries in the event that you die while the funds are still in your inherited IRA.
3. Elimination of The Minimum Life Expectancy of The Oldest Beneficiary
If you are not the sole beneficiary of the inherited IRA, you can take required minimum distributions. However, this must be done over the course of the life expectancy of the oldest IRA beneficiary. Similarly to the first two options on this list, any distribution that you take out over the course of a year will be included in your taxable income for the year.
4. Cash-out the IRA immediately
As the IRA beneficiary, you do have the option to take out 100% of the funds in the IRA account immediately and all at the same time. However, as a caution to this option, you need to be aware that this means 100% of this withdrawal can then be taxed the following year. By taking all of the funds at once, you could inadvertently bump yourself into a higher tax bracket. This means that if you are considering this option that you need to be sure you have enough money to cover the taxes or else you might run into issues with the IRS.
If You Do Nothing…
It is a very good idea to mark the date for the year following the death of the account owner whose IRA you will be inheriting. It does not bode well to procrastinate on this front. If you do not do anything by this date then you will be forced to take Option 1 and you will need to take everything by the end of the fifth year after the IRA account owners death.
What Should You Do?
In case you have inherited an IRA the beneficiary IRA rules discussed above might help you consider more options when handling your inheritance. While it may seem initially appealing, do not immediately pull all of the IRA account money out right away. Next steps might include consulting with a wealth planning lawyer, a tax accountant, or a financial advisor to determine which option is best for you.
Don’t forget to download, save, or share this handy infographic about how to designate your IRA beneficiary IRA for reference:
Do you better understand the Beneficiary IRA Rules For Non-Spouses? Let us know in the comments section below!