Did you recently experience the death of a loved one? Were you a beneficiary on their IRA? An IRA can be a powerful savings vehicle because it offers tax-deferred growth. That means the account owner doesn’t pay taxes on earnings until they take a distribution from the account. In the case of a Roth IRA, the owner may never pay taxes on earnings.
An IRA can also be an effective tool to pass assets to the next generation. It’s driven by a beneficiary designation. That means the account owner names specific people as beneficiaries. When the owner passes away, the IRA custodian pays the benefit directly to the named individuals.
If you’re a beneficiary, you may be tempted to take the money as a lump sum. That may not be the wisest strategy, however. You have a few options available. Below are a few strategies you can take, depending on whether or not you are the owner’s spouse. You also may want to consult with a financial professional to determine the best strategy for your needs and goals.
Options for a Spouse
As the spouse of the account owner, you have more options available than a nonspousal beneficiary, including:
Roll it into your own IRA. This may be the simplest and most straightforward option. As the spousal beneficiary, you have the option to simply roll the death benefit into your own IRA. The funds become a part of your account and are subject to all the same rules as your own contributions. You can’t take a withdrawal until age 59½, and you may have to take required minimum distributions at age 70½.
Open an inherited IRA. You can also open what’s called an inherited IRA. This option is usually taken by nonspousal beneficiaries, but it’s also available to spouses. The IRA is in your name as the beneficiary of the deceased.
You can take the funds as a lump-sum distribution, but you could face taxes on the withdrawn amount. You can also keep the funds in the inherited IRA and start taking required minimum distributions based on your life expectancy. This stretches the tax liability over many years and reduces the impact in any one given year.
Take it as a lump sum. You can always take the death benefit as a lump sum. If the IRA is a Roth, you may be able to take the death benefit on a tax-free basis. If it’s a traditional IRA, however, the distribution will likely be taxable. The distribution could be large enough to push you into a higher tax bracket, which could create other financial challenges.
Options for a Non-Spouse
Did you inherit the IRA from a parent, grandparent or other nonspousal loved one? If so, you have two primary options:
Take the benefit as a lump sum. Again, it can be tempting to simply request the entire death benefit in a lump sum. If the IRA is a Roth, that could even be your best strategy as you may avoid any tax exposure. If it’s a traditional IRA, however, you will likely have to pay income taxes on the full amount.
Open an inherited IRA. Instead, consider rolling the benefit into an inherited IRA. You avoid taxes on the entire amount. You’ll likely be required to take minimum distributions from the IRA every year, but the distribution amount will be based on your age. If you are relatively young, the distributions could be spread out over many years, limiting the tax impact.
Ready to develop a strategy for your IRA windfall? Let’s talk about it. Contact us today at Carstens Financial Group. We can help you analyze your needs and implement a plan. Let’s connect soon and start the conversation.
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