Inheriting an IRA from a loved one can be confusing and costly if you make a mistake.piggy bank balancing on rope

Here are five things to keep in mind if you inherit IRA assets:

1. Decide whether you need the money now.

If you inherit an IRA, you may be tempted to spend the balance. If you cash out an inherited IRA, however, you will pay ordinary income taxes on the full amount of the inheritance.

If you don’t need the money all at once, you may be able to keep the IRA alive for potentially decades. As a general rule, an inherited IRA can mushroom to three to four times its original size over the years if you withdraw only the minimum amount of money required by tax laws.

Stretching an inherited IRA allows you to reduce the amount of taxes owed on each withdrawal and lets the money continue to grow within the account without being taxed.

2. Title the account as an Inherited IRA.

Here’s where using common sense could get you into trouble. Once you inherit an IRA, you may assume that the account is yours. That’s true, but you need to maintain its status as an Inherited IRA account. Only a spouse can treat inherited IRA assets as his or her own by putting the account in his or her name. If any other beneficiary puts his or her own name on an IRA inherited from anyone other than a spouse, the Internal Revenue Service will consider this innocent act a cash out of the IRA and he or she will owe taxes on the windfall.

How can you protect against this nightmare scenario but still claim what is rightfully yours? Make sure the new account title includes the original IRA owner’s name or the term “Inherited IRA.”

3. Keep the money separate from your own IRA contributions.

Don’t ever forget that an inherited IRA has its own unique rules. One of those rules dictates that you can never contribute money to this account. If you add money to an inherited IRA, all the assets in the account become subject to income taxes. That means bye, bye IRA.

4. Don’t forget to take the annual required minimum distribution.

While it’s admirable to want to preserve the IRA, as a beneficiary, you must make withdrawals. Generally, you must begin taking required minimum distributions in the year after the death of the original IRA owner.

5. Consult a tax professional.

After you inherit an IRA, get a professional opinion on how to proceed. IRA inheritance rules can be tricky, and you don’t want to make an irrevocable mistake.

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