Inherited IRA Rules

0:00 Ralph: So here's our question for today. Have you recently inherited an IRA account? Unsure what to do with it or how it works. We'll stay tuned as we break it all down for you today on the show.

0:40 We'll come back to the show on this financial Friday. Today we're diving into the world of inherited IRAs. Now, before we get started, don't forget to subscribe to the show in join our email list. You can do that at askralphpodcast.com. You don't want to miss a thing. And in fact, you don't want to miss tomorrow's episode. we're going to be talking about the new employee versus independent contractor rule. It takes effect on March 11th. You don't want to miss this a big change. inheriting an IRA can seem complex and confusing initially. you just went through a difficult time. You know, someone that you loved or cared about has passed away. And there are many rules and regulations around these accounts that differ from traditional IRAs.

1:22 However, if you have the right information. Inherited IRAs can be managed properly to continue tax deferred growth. So on today's episode, we'll explore what an inherited IRA is. The basics of how it works. Distribution options. That's when you take money out of it, the tax implication and steps you can take. If you've recently inherited one of these accounts. My goal today is pretty simple. I want to provide you clarity and actionable advice to guide you through this process smoothly. So whether you're a spouse child, Or any other beneficiary, that's a person who is the receiver of these funds. Navigating. This is new territory, so let's break it down together. Let's start off by saying what is an inherited IRA?

2:06 First things first. It's simply an IRA account that is in passed on to a beneficiary after the original account owner's death. So for example, Let's say that your mother has passed away. I lost my mother almost a year ago. It's a tough time. And then you compound that with these financial decisions. The beneficiary, inherits the assets and gains control of the account. Now, while I'm here, I want to make sure you take note of this. If you have any IRA accounts or any accounts in general. Make sure you're designating a beneficiary. I've seen this become a huge problem. In absence of a beneficiary. Those IRA accounts can go into an estate and that can trigger a huge tax consequence.

2:49 So here are some key factors to consider when you inherit an IRA. The original IRA account must have designated beneficiaries on the account. So in the case of my mother, for example, If she had an IRA account. She won't say, okay, on the date of my death, this IRA count goes to X, Y, or Z, in my case, it's my sister and I, so let's just use as an example, my IRA account has to be split between my son and my daughter. If, like I said, if no beneficiaries are named assets go to the estate, you want to try and avoid that. Now here's the important part. Inherited IRAs maintained their tax deferred status. Well, that's a good thing because that means the beneficiary can continue growing the account.

3:30 Tax-free until withdrawal. But that's when it gets a little complicated. Withdrawal requirements differ from original IRA owner rules. We'll talk about that in a few moments. So we said assets can remain in the inherited IRA and grow based on how the new beneficiary investor manage them. That's your choice. So in essence, And inherited IRAs, is a tax advantaged account, transferred to a beneficiary to maintain deferred growth potential. It basically remains the same as it was. When the person who set it up. set it up in the first place. But then it gets a little complicated. So let's talk about the distribution rules, how do you get money from that IRA? This is where it gets complex.

4:11 Folks. I gotta be honest with you. And it really comes down to a first decision point. The withdrawal rules vary depending on upon your relationship to the original count owner. What does that mean, Ralph? Well, basically it means this. Your options differ, whether you're a spouse, child, or another beneficiary. So let's talk about spousal beneficiaries first. So husband and wife. Husband passes away. Wife inherits the IRA. So if you inherit an IRA from your spouse, You have more flexibility, they built into the tax code, some more flexibility because. It's your spouse. Here are your options. First thing you can do.

4:51 You can treat it as your own IRA. You can transfer that inherited IRA into your existing IRA or roll it into another IRA. Basically. you change the name of it from your husband's name to your name. This allows you to delay taking money out of it until you reach your requirement of distribution age, which could be as high as 73 at this point. So that's option one. Option two, you can remain the beneficiary. If you choose to remain a beneficiary, you can delay distributions until your deceased spouse would have reached age 73. So you just don't change anything. You just sit on the money. And you wait till you have to take your distributions and then you start taking them. Another option you have is a lump sum withdrawal. You can cash out the entire account immediately and pay ordinary income tax on it.

5:33 It's not ideal from a tax perspective. Let's talk about why. So let's say, for example, in this case, husband passes away. And he has a hundred thousand dollar IRA account. And the wife decides, you know, what. I'm going to make it simple. I'm just going to take the money out. Well, the problem with that is now you've just injected a hundred thousand dollars of income in the current tax year. That could very well put you, it probably will put you in a higher tax bracket. Not an ideal situation. So there are other options. one of those options is a five-year payout. You have the option to empty the inherited within five years. And pay taxes accordingly. Also not ideal for maximizing tax deferral, because you're still going to take that income over five years.

6:17 So in our example, you had that hundred thousand dollar IRA. But you're going to take 20,000 a year. Still going to put you into a higher tax bracket. So as you can see, spousal beneficiaries have more options to continue deferred growth compared to non spouses. So then you ask Ralph, well, what does non-spouse beneficiaries do? For all other beneficiaries like children, the example we talked about here. It was when my mom passed away. If she had an IRA. And she left them to my sister and I her children. The rules are a bit less flexible. So, what are those rules? Ralph? Well, let's talk about it. You can elect what's called a 10-year payout. Any non spousal beneficiary must empty the inherited IRA within 10 years following the original owner's death.

7:01 So it's basically pretty simple. Let's go back to our example. A hundred thousand dollar IRA. Inherited by two children. So each of them will be entitled to $50,000. And they can take that over a 10-year period. So instead of taking 50,000 all in one year, They could basically take $5,000 a year, which isn't going to have a huge tax hit on them. It's not going to unnecessarily put them into a higher bracket. The other option you have. You can do. What's called the annual requirement of distribution. So you have 10 years total to fully withdraw. You must take annual RMDs based on your life expectancy. This prevents the account from growing indefinitely. So if. You are getting close to that RMD date.

7:45 You may have to start taking these withdrawals anyway. Now here's a big issue. There is no rollover benefit. You cannot roll over an inherited IRA into your own IRA. we talked about that spousal IRA where husband passed away and wife decided she would just roll that IRA money into her own IRA. Well, you can't do that if you're not a spouse. So if you're the child, unfortunately, Best case scenario. You're going to have to take that money over 10 years. There's no way of rolling it into your own account and then, waiting until your own retirement date to take. So the goal of these rules is to limit tax deferral advantages for non spousal beneficiaries. I mean, Bottom line is that this money has remained untaxed and the IRS wants to get their hands on it and tax it.

8:31 So you kind of make sure you understand the requirements before managing your distributions. So let's talk about taxes on inherited IRAs. This is a crucial part. He needed to understand the tax implications of these inherited IRAs. While they do maintain tax deferred status, until you take money from them, all the earnings in that are tax deferred. But once withdrawals begin taxes have to be paid. So how are taxes paid? Well, Let me talk about that now. So it draws are taxes, ordinary income based on your tax bracket, just like traditional IRA withdrawals. So for example, Let's say you had a W2 job. You make $50,000 a year. And let's say you have some interest in dividends, that sort of thing.

9:12 Well, this inherited IRA money is just going to add to what we get to what's called your adjusted gross income. So in our example, With the two children, they're going to take $5,000 a year. So they've got that $50,000 W2. Let's say they have a thousand dollars in interest in dividends, and they're gonna have this $5,000 IRA withdrawal. Well, the thing it's complicated as maybe that $5,000 ends up being taxed at the top rate for that particular individual, because it pushed them into that tax bracket. So you have to just be aware of that. Now. If it's a Roth IRA. Withdrawals are tax-free since the contributions were post-tax. So if you happen to inherit a Roth IRA, There are really no tax consequences to that.

9:56 Now, how do you handle those taxes? this is the big surprise. Surprise. I talked about this in another episode. When you go to take that distribution. Most financial brokerage houses are going to ask if you want to withhold tax. And they're generally going to suggest you withhold 20% again. This depends on your personal tax situation. That's why I'm going to tell you to speak to a professional. If you want to talk to me, you can go to my website. That's at askralphpodcast.com/store. There you can schedule an appointment with me. Because you don't want to spend all this money because there is going to be a tax consequence, but it's going to depend on your particular situation. Now, one of the things that's very good about this. Is there is no penalty.

10:38 There's no 10% early withdrawal penalty. Where am I getting that from? So here's the deal. If it was your own IRA. And you took that money out before you reached 59 and a half. The IRS charges, a 10% penalty for what they call premature distribution. But you don't have to worry about that when you inherit an IRA. Any withdrawals you take. Have to be reported on your personal tax return. It's also generally income at the state level. So don't forget about those state obligations. The bottom line is that inherited IRAs function. Very similar to traditional IRAs from a tax perspective. It's really not much of a difference. But you need to talk with a tax advisor, a tax professional, determine the specifics for your situation.

11:22 So Ralph. What are the action steps? you always try to give us action steps. Well, I'm going to give them to you right now. If you're navigating this process, currently here are some steps to take number one. Notify the custodian inform the bank or the firm holding the IRAs that original owner has passed away. They're probably going to ask you for a copy of the death certificate. Get in touch with those people and get that process going. Step number two, you need to understand your distribution options. we talked about those. Review the rules we discussed based on your relationship. if you're a spouse, there are certain set of rules. If you're a non-spouse there's other rules and you got to consider the tax implications while you're there. Now here's a step that a lot of people forget about and that's step number three. I designate new beneficiaries.

12:04 So if you choose to maintain it as an inherited IRA, and I see this step, skip sometimes. Be sure to name a new beneficiary in case you pass away before you distribute all the money out, we don't want to end up having this money go into an estate. Number four. I can't stress this enough. Consult a tax advisor, connect with a financial professional to discuss your specific situation because everybody's situation is different. And help them. Put together a strategy for managing this inherited IRA. Once you do that, you're going to go on to step number five, which is create a withdrawal plan. Based on the distribution rules decide when and how much do you want to withdraw? factor in the tax consequences of that. That's the key part of why you want to develop a withdrawal plan.

12:47 The worst case scenario is you just say, I'll just give me the money. It might be the best situation depending upon your particular individual tax situation, but it could really trigger a big tax issue. Number six, seek guidance on investing. So if you want to assets to continue to grow tax deferred, you've got to work with an investment advisor to give you a good option of what to do with those assets. And this one is very important. This is step number seven. Maintain proper documentation, keep records on all IRA transactions, taxes paid on distributions in any other supporting document information, because at the end of the year, You're going to come and see your tax advisor. I see these routinely in my practice.

13:28 You got to bring all the documents, you're going to get a 1099R at the end of the year, which shows how much money you took out. On that 1099R it's going to show the taxes that were withheld. The truth is folks. The more you're informed, the easier this process will be. it's a tough time to begin with. Right. You just lost a loved one. But you've got to seek guidance from financial and tax professionals when you need them. So before we wrap up today, I want remind all of our listeners do visit our podcast page, I mentioned at a time or two. That's at askralphpodcast.com. There you can leave a review, share your thoughts and even send us a message with questions for future episodes is our microphone. The bottom right corner click on that record a message. You can send us an email. And while you're there.

14:09 Join our email list to enter into our weekly $25 Amazon gift card drawing. You don't want to miss that folks. We're giving away weekly, a $25 gift card. Well, why are you doing that? Ralph? I'm trying to build listenership. I'm trying to connect with the listener so that I can let them know when things are going on this show. And as I mentioned. If you have a situation that you need. Expert professional advice. You can book an appointment with me right there. That's at askralphpodcast.com/store. And I can sit down with you. If it doesn't matter where you live with zoom, we can do it from wherever you are. And I can give you some specific advice. Suited towards your particular situation. So let's recap. Inherited IRAs can seem daunting at first glance.

14:52 But now you have a much deeper picture of what they are and how they work. The key is understanding the distribution options. The tax implications and steps take if inheriting one. Use this knowledge to manage your inherited IRA intelligently. So in closing as always visit our podcast page. For more resources about this topic, feel free to reach out with any questions. These IRAs don't have to be confusing. Well, thank you for joining me today. Let's continue our journey Grounded in faith, stay financially savvy, and God bless you.