IRAs (Individual Retirement Account) are great investment vehicles for tax deferred growth and estate planning. An IRA has a designated beneficiary when the account is set up that makes it easy to determine who should inherit the money. Usually the beneficiary is a spouse but sometimes it is a minor or a non-spouse. It gets tricky when the beneficiary is a non-spouse. Let’s look at your options if you are a non-spouse beneficiary of an IRA.
Your first option and my personal favorite is called the Stretch IRA which means you start taking the required distributions which are based on your single life expectancy (which is a factor in a table published by the IRS) using your age at the end of the year. You must begin taking the first distribution in the year after the death of the IRA account owner. There is no penalty for taking the distributions regardless of your age but your distributions are taxable. The money in the IRA account is left to grow tax deferred throughout the beneficiary’s lifetime. That’s a great feature that is too good to pass up. Think about it. You are taking a little bit of money over a long period of time so the lump sum keeps growing without any tax on the earnings. What a deal!
Your other option is to use the 5 year rule. This rule says that all of the funds must be distributed by the end of the fifth year after the account holder’s death. You can take the money out whenever you would like and there is no penalty but again, you would have to pay tax on the distribution. This obviously is better for very small amounts of money or perhaps minors that may need the funds for education or other purposes.
Be careful when transferring title from an IRA to an inherited IRA. There are strict rules about that, and if the bank or brokerage firm does it incorrectly (and believe me, I have seen it happen), you could incur taxes and penalties.
Be careful with your beneficiary designations. It is prudent to review them every couple of years. A large Individual Retirement Account can be a wonderful inheritance that can last a lifetime. See your Financial Advisor or a Wealth Coach to help you grow your money.