Periodically, The State’s financial columnists, Ashleigh Brooker and Neil Brown, certified financial planners in the Midlands, will offer their views on a question from a reader. This week’s question:
I have inherited a traditional IRA so what do I need to do now?
The best answer comes from my tax professor at USC, Dr. Rich White, “it depends.” It depends on whether or not you are a spouse of the deceased.
If you are a non-spouse, you have two options. You may simply cash out the IRA, pay all of the federal and state taxes associated with such, and use the money as you wish. This is the worst choice. While you are not subject to any early withdrawal penalties, regardless of age with an inherited IRA, you are speeding up the tax consequences and making any growth on the money held outside of the account subject to taxes annually.
A better option would be to treat this as an Inherited IRA. The first thing you should do is open an inherited IRA in order to receive the proceeds. The account title should show both the deceased’s as well as the inheritor’s names. For example, Kim Smith Deceased IRA For the Benefit of Brianna Byrd.
Once the account is set up, you can move the inherited money into this account only via a trustee-to-trustee transfer. You cannot receive a check and then deposit the money into the account. Once the money is in the account, you must begin taking minimum distributions, in the year following the owner’s death, over your life expectancy using a special IRS table. In doing so, this will allow the money to grow with a lower annual tax hit and you still have the flexibility to take this money out as you wish.
If you are the spouse, your options are somewhat different. To paraphrase Neil, the cash-out option is the IRS’ dream. Therefore, strive to execute a more tax efficient option that extends the benefits of tax-deferral.
First, determine when you will need the money. You and your spouse’s ages also are factors. If you can wait years to take withdrawals and are younger than your spouse, then one option involves transferring the IRA into your own name. Doing so allows you to delay the date that you are required to take Required Minimum Distributions until you are 70.5.
Additionally, transferring the IRA into your own name enables you to use a joint table for calculating your required distribution, resulting in a lower amount. This is especially important for widows who do not need as much money from the account and want to minimize their tax liability.
Option two involves leaving the IRA in your spouse’s name. While this option may seem attractive for its simplicity, there are some key differences between this and the first option. First, it requires you to take distributions as if you are the age of your deceased spouse. You must also use the single life table to calculate these distributions, effectively increasing your distribution and corresponding tax bill. This works well if you are older than the deceased.
In some cases, it is appropriate to combine both options for the long-term benefit of the surviving spouse.
A spouse can also treat an IRA as Inherited and use the rules as Neil describes above. The best option for you simply depends on your personal situation. However, it is important your spouse be named the beneficiary if you want to have this flexibility.
Consult your financial team to devise a strategy that is appropriate for you.
Life is a journey, plan for it.
Ashleigh Brooker, CFP, is the principal of A.J. Brooker Financial Associates in Columbia. Contact her at info@AJBrooker.com or (803) 724-1235. Neil A. Brown is a CPA and CFP with Burkett Financial Services in West Columbia. Contact him at www.uscneil.com or (803) 200-2272.