Are you going to inherit an IRA from a spouse, parent or other loved one? Thinking about leaving yours to someone else after you go? There are highly complicated rules that govern inherited IRAs and required minimum distributions (referred to as RMDs) from these tax-deferred accounts. If the inheritor makes a mistake there are severe financial penalties. Here are a few points to think about before you consult with your legal and financial professionals.
When You Have To Begin: The inheritor must begin taking RMDs from the inherited IRA by December 31 of the year after the original account owner’s death. Example: If mom died March 1, 2016, distributions must begin by no later than December 31, 2017. (One exception: if you are inheriting from a spouse, you might be able to delay the start of RMDs until the year your deceased spouse would have turned 70 1/2, depending on how you take the account.)
Steep Penalties: If you fail to take the correct required minimum distributions, your penalty will be 50% of what you should have withdrawn. Ouch. This is not a calculation you can afford to miss.
Inheriting Spouses Have A Big Choice: Surviving spouses may choose to roll the IRA assets into their own IRA or put them into a separate Inherited IRA account (as all non-spouses must). The choice affects the RMD calculations significantly. If you roll the assets into your own IRA you will get to use the favorable IRS Uniform Lifetime Table in making the RMD calculations, and the RMDs will be lower than if you put the assets in a separate inherited IRA. There are many reasons why this is a good idea, including the fact that RMDs are taxed as ordinary income and if you don’t actually need them to live on, they just drive you into higher tax brackets. But there is also a big reason not to go this route: if you are under age 59 1/2 and may actually need to use account assets beyond the RMDs, this choice would subject you to 10% “early withdrawal penalties” on withdrawals. This is a choice you need to consider carefully with legal and financial professionals so you don’t make an expensive mistake.
Exactly How Much Do I Have To Take Out? As with everything, it depends. Calculating RMDs (for anyone other than an inheriting spouse who rolled over into their own IRA) requires a number of variable factors: your age, the IRS Single Life Expectancy Table, the account balance on December 31 of the prior year, and a calculator. There are many good online worksheets to help you with this. You need to recalculate the amount annually. And there will be no early withdrawal penalty for RMDs even if you are younger than 59 1/2.
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