Options When Inheriting a Retirement Account

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Losing a loved one is always difficult and to make things tougher, some important financial decisions often need to be made soon afterwards. If you were named the beneficiary on a retirement account such as a 401(k), 403(b), or IRA you typically have a couple of options for handling this inheritance. If the decedent was a spouse, there is a wider range of options, but for now we will focus on non-spouse inherited retirement accounts.

            If the decedent was under age 70 ½, you as the non-spouse beneficiary can keep the money in the existing account but must take distributions in one of two ways. You can choose to distribute the entirety of the account no later than December 31st of the fifth year following the year the account owner died.  Alternatively, you can elect to distribute the account in one lump sum. In either case, you will not be charged the 10% early withdrawal penalty if you are under age 59 ½, however, you must include the distribution in your income and pay income taxes on it. Depending on the size of the account, the distribution could push you into a higher tax bracket. It’s best to consult with a tax professional to determine the appropriate distribution timeline.

            Another option is to transfer the money from the decedent’s retirement account into an inherited IRA. These accounts are specifically designed for retirement accounts inherited by a non-spouse beneficiary and allow you to distribute the money based on your life expectancy instead of the decedent’s. Each year you are required to distribute a portion of the account based on the previous year-end account value and your IRS life expectancy factor. For example, if the account value was $100,000 on 12/31/18 and you turn 45 years old during 2019, you would divide $100,000 by your IRS life expectancy factor of 38.8. Your resulting Required Minimum Distribution (RMD) would be $2,578 for this year, and it must be taken by December 31st and included in your taxable income for the year. NOTE: unlike your own IRA which allows for the IRS factor to be taken from published tables, inherited IRA factors are generally calculated based on the age the beneficiary will attain the year after the original account owners death, then reduced by 1 for each subsequent year.

While you can always take out more than the RMD each year, you must take at least the calculated amount or the penalty for failing to do this is severe. You must pay a 50% tax on any amount that fell short of the RMD. It is important to remember that each year the RMD must be recalculated since the year-end account value as well as your life expectancy factor will change.

            The primary benefit of taking the inherited IRA route is that you can spread the distributions over a longer period of time, leaving the remainder of the accounted invested to hopefully continue growing tax deferred.

            If the decedent was over age 70½ you also have two options for distributing the account. Since they were already taking RMDs at the time of death, you can continue withdrawing the RMD based on their IRS life expectancy factor, meaning you are not forced to distribute the full amount in the 5-year window. You can take out more than the RMD but not less or else the 50% tax applies. The other option is to move the money into an inherited IRA and base the RMDs off your own IRS life expectancy factor as described above. 

The rules for non-spouse inherited retirement accounts can be complex so we recommend discussing your options with your financial advisor or tax professional.           

Jeff Witz, CFP® welcomes readers’ questions.  He can be reached at 800-883-8555 or at witz@mediqus.com.                                                                                                              

200 North LaSalle Street – Suite 2300 – Chicago, Illinois 60601

312-419-3733 – Toll Free 800-883-8555 – Fax 312-332-4908 – www.mediqus.com

Investment advisory services offered through MEDIQUS Asset Advisors, Inc. Securities offered through Ausdal Financial Partners, Inc.  Member FINRA/SIPC ∙ 5187 Utica Ridge Rd ∙ Davenport, IA 52807 ∙ 563-326-2064 ∙ MEDIQUS Asset Advisors and Ausdal Financial Partners, Inc. are independently owned and operated.

Effective June 21, 2005, newly issued Internal Revenue Service regulations require that certain types of written advice include a disclaimer. To the extent the preceding message contains written advice relating to a Federal tax issue, the written advice is not intended or written to be used, and it cannot be used by the recipient or any other taxpayer, for the purposes of avoiding Federal tax penalties, and was not written to support the promotion or marketing of the transaction or matters discussed herein.

The information contained in this report is for informational purposes only. Any calculations have been made using techniques we consider reliable but are not guaranteed. Please contact your tax advisor to review this information and to consult with them regarding any questions you may have with respect to this communication.

MEDIQUS Asset Advisors, Inc. does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.

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