An inherited IRA can be a great thing for the beneficiaries. It is almost like winning the lottery or the Reader’s Digest sweepstakes. You get income for life, or do you? It is all too easy to miss out on this opportunity. The following apply to beneficiaries who are named on the beneficiary form. Beneficiaries who inherit through an estate or trust have different rules.
1. Relying on the IRA Custodian – The company that is holding your inherited IRA will let you know what the best option is for you, right? Wrong. They are not required to give you any information. In fact, their only obligation is to issue the appropriate tax reporting for transactions that are made on the account, and many times they don’t even get that right.
2. Doing 60-Day Rollovers – IRA assets inherited by anyone other than the account owner’s spouse can only be moved in a direct transfer from one IRA custodian to another. Any distribution payable to a non-spouse beneficiary is taxable. There is no fix for this mistake.
3. Not Stretching the Inherited IRA – Taking a lump-sum distribution wipes out the inherited IRA. The beneficiary must pay income tax on all pre-tax amounts distributed. When the inherited IRA is kept intact and only RMDs are taken each year, the account can continue to grow and compound on a tax-deferred basis (tax-free for inherited Roth IRAs) until the beneficiary is in his early 70’s. At that point RMDs being to exceed the earnings on the account and the IRA will eventually be paid out in full.
4. Not Splitting an Inherited IRA into Separate Accounts – When there are multiple beneficiaries named on an inherited IRA, each beneficiary can use their own life expectancy for calculating RMDs IF the account is split into separate accounts for each beneficiary by 12/31 of the year after the account owner’s death.
5. Not Taking RMDs – All non-spouse beneficiaries have RMDs beginning in the year after the account owner’s death. This includes Roth IRA beneficiaries and beneficiaries of all ages. The RMDs will be based on the beneficiary’s age in the year of the first distribution as determined by the Single Life Expectancy Table. The factor for the first year will be reduced by one in each subsequent year.
6. Spouses Have Different Options – A spouse can remain a beneficiary of the inherited account. She will use the Single Life Expectancy Table but look up her factor each year. But she can delay her first RMD until the deceased spouse would have been 70 ½. A spouse can do a 60-day rollover of inherited IRA assets to an IRA in his own name; neither of which a non-spouse beneficiary can do.
7. Not Naming a Successor Beneficiary – The beneficiary of the inherited IRA should always name their own beneficiary – the successor beneficiary. If the beneficiary dies while there are still assets in the inherited IRA, the successor beneficiary will inherit the inherited IRA instead of it going to the deceased beneficiary’s estate. The successor beneficiary continues to receive the annual RMDs of the deceased beneficiary, as if the deceased beneficiary were still alive. The successor beneficiary cannot reset the RMD calculations to their own age.
When you inherit an IRA, you should consider working with an advisor who is knowledgeable in the area of IRAs and especially inherited IRAs. Don’t depend on the IRA custodian, or even IRS, to give you the correct answers to your questions or to provide guidance. Mistakes can be very costly and can easily mean the end of the inherited IRA.