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You may consider inheriting assets as a blessing but if you do not study their implications, you may end up with a liability instead. Particularly, you want to continue the potential for tax-advantaged growth of these assets while avoiding their income tax impact.
Your options about the inheritance will depend on your legal relationship with the original owner. It would be a good idea to discuss all your available options with your lawyer or tax advisor before making a move.
This is important if creditor protection is a prime consideration for you. The Supreme Court has ruled that Inherited IRAs do not enjoy protection under federal bankruptcy laws. Inherited IRAs though, still enjoy creditor protection from state-to-state laws.
After we are already covered the options in case you of spouse inheritance, here are your options if you inherited an IRA or workplace savings account directly from someone other than your spouse (:
Option 1: You can roll over the inherited assets to another IRA account. You can then begin taking minimum required distributions by December 31 of the year following the account owner’s death.
Option 2: You can cash out or take cash distribution of your share of the inherited amount.
Option 3: Waive your right over the inheritance. You can disclaim all or part of your share within nine months of the owner’s death so they pass to the next eligible beneficiaries.
Option 4: You can just leave the assets in the plan. If permitted, you may be able to transfer the inherited assets to an inherited account in the plan.
Let’s explain each of them:
Option 1: Roll over the inherited assets
You can then begin taking minimum required distributions by December 31 of the year following the account owner’s death.
How you move your inherited assets will depend on the type of the inherited retirement account. Generally, if it’s from an IRA (e.g. Traditional, Roth, Rollover and Simple), and you choose to directly roll it into another account, you’ll have more control. You can dictate how the fund managers can invest your assets and to whom they pass when you die. They will also determine your MRDs based on your own life expectancy.
Make sure that you roll the assets directly to an Inherited IRA and that the fund manager does not issue a check in your name for those assets. You can also directly roll over an inherited workplace savings account such as a 401(k) or 403(b) to an Inherited IRA. By doing this, you can begin taking MRDs by December 31 of the year following the original owner’s death.
You can only directly roll over to an Inherited IRA plan with a non-spouse beneficiary as a distribution option. Talk to the inherited plans provider on how to go about the transfer of these assets.
For you to do this, the assets should already be under your Inherited IRA account. Remember that this will form part of your gross income so expect it to have a tax component.
Generally, in order for the cash distribution to be possible, the assets must already be in an Inherited IRA or Inherited Retirement Plan Account. The type of inherited account will dictate the details but your distribution will be subject to ordinary state and federal income taxes.
Current tax laws require a mandatory 20% withholding tax for all distributions coming from retirement plan accounts such as a 401(k) or 403(b).
Option 3: Waive Your Right To The Inheritance
You can disclaim all or part of your share within nine months of the owner’s death so they pass to the next eligible beneficiaries.
Let’s say that after consulting with your lawyer or tax advisor, you realize that you don’t actually need all or most of your inherited assets during your lifetime. You can decide to disclaim (basically, refuse) to inherit all or part of the assets you inherited.
If you disclaim, the inheritance would then pass on to the next eligible beneficiaries. Henceforth, any mandatory minimum distributions would then follow the new beneficiary’s age and not your own. Younger beneficiaries (in relation to your age) would, in effect, have a longer potential for tax-deferred growth on the assets.
Tax rules will only allow you to disclaim assets within nine months of the IRA/Retirement Plan account owner’s death. Be sure that you’ve talked this option thoroughly with your tax or legal advisor before you make a decision. Find out also if the deceased’s state of residence requires an Inheritance Tax Waiver. A disclaimer is irrevocable – when you give up your right to inherit the IRA/Retirement Plan assets, you can’t take it back.
Option 4: Leave The Assets in The Plan
You can check if the plan you are inheriting will allow you to leave the assets in the plan. Talk it over with the workplace savings plan administrator because not all plans have the same details.
If you choose to transfer assets to an Inherited Plan Account then leave the assets in the plan, it affects the MRDs. You must generally take MRDs according to the plans distribution options provided for non-spouse beneficiaries. The sponsoring employer must continue to administer the plan. In case the decedent was also the sponsoring employer, an Inherited Retirement Plan Account is not an ongoing option.
If the original owner was over 70 ½ years old and still owned by MRDs for the year he/she died, you must generally withdraw the appropriate amount by December 31 of the decedent’s year of demise. The MRD amount they distribute to you as a beneficiary in the year of death should comply with the Retirement Plan Account owner’s MRD schedule. However, they will use your tax ID number for the distribution. You cannot roll over the MRD.
There are 2 important considerations you should take into account:
1. Minimum required distributions (MRDs)
Generally, when beginning MRDs from an Inherited IRA, the deadline is December 31 of the year following the original owner’s death.
If the decedent is 70 ½ or older at the time of death, you cannot roll over any MRD amounts due prior to or during the year of the direct rollover. Also, you must generally withdraw the prescribed amount on or before December 31 of the year the original owner died.
You’ll receive the MRD amount as the beneficiary in the year of death according to the original owner’s MRD schedule. However, they will use your tax ID number for the distribution.
2. Multiple Beneficiaries
If you are sharing Inherited IRA assets with other beneficiaries, you have to do something within the year.
Set up your own Inherited IRA for your portion of the Inherited IRA assets by December 31 of the year following the original owner’s date of death. It would be wise to consult with your accountant or lawyer about your unusual situation. If you do not separate your inherited IRA assets by the deadline (December 31), they will base their MRDs on the age of the oldest beneficiary on the account.
In some cases, the calculation can accelerate the MRDs from your account.