Tax deferral is a key benefit of investing in a traditional individual retirement account (IRA). But the tax law doesn’t allow indefinite tax deferral. Starting at age 70½, IRA owners must withdraw a minimum amount — called a required minimum distribution, or RMD — every year. All funds withdrawn from a traditional IRA are taxed as ordinary income except for nondeductible contributions, which aren’t taxed again.
A beneficiary who inherits a traditional IRA doesn’t receive a pass on income taxes. If you inherit an IRA, be cautious about simply liquidating the account, since the tax bite could be quite large. Instead, talk with us about your distribution options.
As a Surviving Spouse
You can leave the account as is and designate yourself as the account owner, assuming you are the sole designated beneficiary of your spouse’s IRA. Or you can roll the funds over into your own traditional IRA. Either way, you won’t have to take any money out until after you reach age 70½. Then, you’ll have to start taking RMDs. If you want to, you can allow the rest of your IRA to continue growing tax deferred.
A surviving spouse can also choose to be treated as the IRA beneficiary. This might be the better choice if you’ll need to take money from the IRA before you turn 59½, since withdrawals by IRA beneficiaries escape the 10% tax penalty on early withdrawals. What about RMDs? If you go the beneficiary route, you generally won’t have to start taking them until the year your spouse would have reached 70½.
As a Nonspouse Designated Beneficiary
You can also stretch out withdrawals — and the related income taxes — by setting up an inherited IRA. The deadline for taking your first RMD is December 31 of the year after the year the account owner died. You may make additional withdrawals from the IRA at any time.
Somewhat different rules may apply if you receive an IRA that has passed through an estate instead of directly to you as the account’s designated beneficiary. To get the most from your IRA inheritance, you’ll want to carefully evaluate your options or talk to your Herbein tax professional.