Inherited IRAs face new rules, potentially causing high tax bills for heirs.
Inherited IRAs face new rules, potentially causing high tax bills for heirs.
New Inherited IRA Rules and Taxes: What You Need to Know
Inherited IRAs have always been a popular way for parents to pass down their hard-earned savings to their children. However, recent changes in the law and the IRS’s interpretation of those changes have introduced new tax consequences for beneficiaries. It’s important to understand these changes to avoid any surprises when it comes to your inheritance.
The Impact of the SECURE Act
The Setting Every Community Up for Retirement Enhancement (SECURE) Act, which was signed into law in 2019, brought significant changes to the taxation of inherited IRAs. Under the old rules, beneficiaries could extend withdrawals over their life expectancy, minimizing their tax bills. However, for most adult children, grandchildren, and non-spouse heirs who inherited a traditional IRA on or after January 1, 2020, this tax-saving strategy is no longer available.
Now, non-spouse heirs have two options: take a lump sum and pay taxes on the entire amount or transfer the money to an inherited IRA and deplete it within 10 years after the original owner’s death. The 10-year rule also applies to inherited Roth IRAs, but withdrawals from Roth IRAs are tax-free, providing more flexibility.
Initially, tax experts and financial planners believed that non-spouse heirs could withdraw the money at any time in any amount as long as it was depleted within 10 years. However, the IRS’s interpretation of the SECURE Act clarified that if the original owner had started taking required minimum distributions (RMDs), the heirs must follow the RMD schedule based on their life expectancy in years one through nine and deplete the balance in year 10.
Calculate How Much to Withdraw
If you’re required to take a minimum distribution from an inherited IRA, you can use the factor in the IRS Single Life Expectancy Table to calculate your distribution. Divide the balance of the IRA at the end of the previous year by the life expectancy factor for your age. It’s important to note that you can withdraw more than the minimum if it aligns with your financial goals, but be mindful of potential tax implications.
- Yellow Corp financial troubles not widespread – White House a...
- German data watchdog investigates Worldcoin crypto project, officia...
- Mexico’s stronger peso reduces US remittances’ value.
Tips for Managing Your Inherited IRA
When it comes to managing your inherited IRA, there are several crucial steps to follow. First, you must open an inherited IRA account since you can’t leave the money in the original owner’s account or roll it into your own IRA. Request a trustee-to-trustee transfer of funds to your inherited IRA to avoid taxation on the entire amount.
Once you’ve set up your inherited IRA, you can invest the money based on your goals and risk tolerance. Remember that taxes on the funds will be deferred until you take distributions, so it’s essential to plan accordingly. Be prepared to provide necessary documents and contact the financial institution to complete the transfer process.
Options for Spousal Beneficiaries
Spousal beneficiaries have more flexibility than non-spousal heirs, but they still need to make important decisions. They have the option to treat the inherited IRA as their own, roll it into their own IRA, or transfer the funds into an inherited IRA. Each option comes with its own benefits and requirements, offering spouses various choices based on their unique circumstances.
Leaving a Tax-Friendly Legacy
If you’d like to leave your children a tax-friendly legacy, there are strategies to consider. One approach is converting some funds from your traditional IRA to a Roth IRA. While non-spouse heirs must deplete a Roth within 10 years, withdrawals from Roth IRAs are tax-free. By choosing this strategy, your heirs can let the money grow tax-free for a decade or withdraw as needed, without worrying about taxes.
It’s essential to evaluate your tax rate compared to your heirs’ rates before making any conversions. Additionally, the step-up in cost basis for assets held outside of tax-deferred accounts can provide significant tax advantages for your heirs.
Final Thoughts
Understanding the new rules and taxes regarding inherited IRAs is crucial for anyone who might receive such an inheritance. By being aware of the changes brought by the SECURE Act and the IRS interpretation, you can make informed decisions to manage your inherited IRA effectively. Seek guidance from tax experts and financial planners to develop a personalized plan that aligns with your financial goals.
