An Individual Retirement Account (IRA) is a great way to leave a legacy. However, mistakes are commonly made when IRAs are passed to heirs. In general, all earnings in the IRA grow tax-deferred. A beneficiary of a traditional IRA will owe income taxes when the money is taken out of the account. A beneficiary of a Roth IRA will receive the money tax-free.
When a surviving spouse inherits an IRA, he or she can re-title it in his or her own name or roll-over the account into a new IRA tax-free. With a traditional IRA, the surviving spouse can leave the money alone until age 70½. When the surviving spouse reaches age 70½, he or she must start taking the required minimum distributions. There are no required minimum distributions for a Roth IRA.
Younger surviving spouses should be careful when inheriting an IRA so that it does not become taxed. If a surviving spouse is under age 59½ and needs some of the IRA money, there is potentially a 10 percent penalty. However, if the deceased spouse’s account is re-titled as an “inherited IRA,” the surviving spouse can avoid the penalty. Please keep in mind that an “inherited IRA” should be re-titled again into the name of the surviving spouse’s name alone once he or she reaches age 59½. Otherwise, withdrawals must start when the deceased spouse would have reached age 70½ instead of when the surviving spouse reaches age 70½.
If a nonspouse inherits an IRA, it cannot be rolled over into his or her name. A nonspouse can re-title the account as an “inherited IRA.” Every year, the beneficiary will need to make a minimum withdrawal based on his or her age, but he or she can take more if desired. These withdrawals are taxed and the rest of the money left in the IRA accumulates tax-deferred.
Having the proper title on an IRA is critical. Please consult with your financial advisor or attorney to ensure your beneficiaries will not lose out on the great opportunities of inheriting an IRA.