An IRA can be a powerful wealth-building tool, offering tax-deferred growth (tax-free in the case of a Roth IRA), asset protection and other benefits. But if you leave an IRA to your children — or to someone else other than your spouse — these benefits can be lost without careful planning.
“Inherited IRA” stretches tax benefits
A surviving spouse who inherits an IRA is permitted to roll that IRA into his or her own IRA, allowing the funds to continue growing tax-deferred or tax-free until the funds are withdrawn in retirement or after age 70½. Beneficiaries who are not your spouse are treated differently.
To take advantage of an IRA’s tax benefits, nonspouse beneficiaries must transfer the funds directly into an “inherited IRA.” Even then the beneficiaries will have to begin taking distributions by the end of the following year, but they’ll be able to stretch those distributions over their life expectancies.
This option is only available to your children or other non-spouse beneficiaries if you name them as beneficiaries (or secondary beneficiaries) of your IRA. If you leave an IRA to your estate, your children or other heirs will still receive a share of the IRA as beneficiaries of your estate, but they’ll have to withdraw the funds within five years (or, if you die after age 70½, over what would otherwise be your actuarial life expectancy).
If you name multiple nonspousal beneficiaries (several children, for example), each beneficiary will have to establish a separate inherited IRA account by the end of the year after the year of your death in order to take distributions over their respective life expectancies. If any beneficiary misses the deadline, he or she can still roll the distribution into an inherited IRA but he or she will have to use the oldest beneficiary’s life expectancy as the time over which they must remove the monies.
Be aware that, unlike other IRAs, inherited IRAs aren’t protected from creditors in bankruptcy.
Inherited IRA rules
The following special rules apply to an inherited IRA:
- The IRA must be a new IRA set up for the specific purpose of receiving the inherited account.
- The IRA must be specially titled in the deceased account owner’s name.
- No other contributions may be made to the IRA.
- No other amounts may generally be rolled into or out of the IRA.
- Required minimum distributions will need to be made over the beneficiary’s life expectancy starting the year after the IRA owner’s death.
Please contact us if you have questions about how to address your IRA in your estate plan.