An Individual Retirement Account (IRA) is a great way to save for retirement. An IRA also can be a great inheritance for your heirs – if done properly. One wrong move and you may owe a huge amount in taxes.
The biggest benefit of an IRA is the tax benefits. All of the interest, dividends and gains in the IRA grow tax-deferred, helping your money grow faster through compound interest.
With a traditional IRA, any money that is withdrawn is taxed; with a Roth IRA, the money is tax-free. In either case, a good strategy can maximize money for your heirs by keeping it in the IRA as long as possible.
- Strategies for a spouse. If you are a spouse who is inheriting the IRA, you can retitle it to your name or roll it over to a new IRA in your name. However, if you are under the age of 59.5, you will owe a 10 percent penalty for any money withdrawn. You can avoid this penalty by retitling it as an “inherited IRA.”
There are specific rules to be retitled correctly. If John Doe leaves his IRA to his wife, the IRA is retitled “John Doe IRA (deceased Oct 1, 2012) for the benefit of (FBO) Jane Doe, beneficiary.” (Please see a professional for more information.)
Jane can now withdraw money even if she is under 59.5, with no penalty. Once she reaches that age, she can retitle again to her name. This allows her to not take any required minimum distributions (RMDs) until she is 70.5, allowing for a longer tax deferment. If she doesn’t do this, she will have to take the RMDs when her late spouse would have reached 70.5, which in this case would be sooner.
- Strategies for children. If you are a child receiving the IRA, you are not allowed to roll it over in your name. If you decide to withdraw all the money at once, you will owe taxes on the entire account if it’s a traditional IRA and lose out on the best part of an IRA, the tax-deferred status. You also can retitle the IRA as “inherited IRA” to maximize the tax-deferred accumulation.
If there are multiple children, they will each need to retitle it appropriately in separate accounts. Every year you will have to take out your RMDs or more if you wish. Bottom line is that depending on how much is withdrawn, the tax benefits can continue for several generations!
Retitling an IRA for heirs is very important – if not done properly, you can be taxed quite a bit and lose out on the tax shelter. You can do the same thing for a 401(k) plan if you inherit it. Anyone leaving an IRA to their heirs should make sure retitling IRAs is part of the estate plan to maximize the benefits.