IRA as an Inheritance

IRA as an Inheritance
A Spouse Inherits

If you are a spouse who inherits an IRA from your husband or wife, you can put the IRA in your own name ("re-title" it) -- this is the simplest way -- or roll the money, tax-free, into a new IRA, in your name.  

If it's a Traditional IRA, you can leave the money alone until you reach 70 1/2, at which time required minimum distributions begin.  With a Roth IRA, any money you don't need can stay in the Roth for the next generation.

There is a "tax wrinkle" for younger spouses.  If you need the IRA money, you can potentially owe a 10% penalty, if you withdraw money and are under 59 1/2.  You can avoid the penalty by re-titling the account as an "inherited IRA."

The rules on re-titling are very specific.  As an example, say John Jones dies, leaving his IRA to his young wife, Mary Jones.  The account should be re-titled "John Jones IRA (deceased August 01, 2012) for the benefit of Mary Jones, Beneficiary."  Once this is done, Mary Jones can take the money penalty-free.  There is one more step -- younger wives, please note.  When Mary reaches 59 1/2, she should re-title the account again, this time in her name alone.  This lets her defer any further withdrawals until she reaches 70 1/2.  If she doesn't do this, withdrawals must start when her late husband would have reached 70 1/2.

A Child or Non-spouse Inherits
If a child receives an IRA from a parent, the child cannot roll the money into an IRA in the child's own name.  If the child decides to cash out, two things happen:
1)  if it's a Traditional IRA, the child will owe income tax,
2)  the multi-year (even multi-decade) tax shelter that an inherited IRA provides would be lost. 

So, the child should re-title the account as an "inherited IRA."  For example, say John Jones leaves his IRA to his daughter, Joan.  Joan should re-title the IRA "John Jones IRA (deceased August 01, 2012) for the benefit of Joan Jones, Beneficiary."  If the money is to be divided among heirs, each recipient should re-title his or her share.  Every year, the child is required to take a minimum withdrawal, based upon the child's age, but the child can take more if they want.  Remember, withdrawals are taxed, the remainder accumulates tax-deferred.

Now, if Joan dies, naming her son, Jack, as beneficiary, Jack can re-title the account as an "inherited IRA" and complete the withdrawals on the same schedule that Joan began.  The family deferrals could last for decades.

What if you inherit a 401-K?  That too can be re-titled as an "inherited IRA."

If re-titling is wrong, the recipient will be taxed immediately, on the whole amount.  A lawyer who handles the will can assist heirs in re-titling IRA's.  Or, send a letter to the mutual fund group that holds the IRA, specifically asking that a separate "inherited IRA" for each beneficiary be created.

Anyone holding an IRA or 401-K should leave a "note" explaining re-titling so their heirs can get as much tax deferral as possible from the money you leave them.

Synopsis:
Rollover to beneficiary
Distributions of benefits from a deceased employee's eligible retirement plan may be rolled over directly to an IRA of a beneficiary who is not the surviving spouse of the employee [IRC §402(c)(11)].  The IRA is treated an an inherited IRA of the beneficiary.  Distributions from the inherited IRA are subject to the distribution rules applicable to beneficiaries.  A non-spouse beneficiary who inherits an IRA cannot treat it as his or her own account but must take RMDs determined under the rules applicable to beneficiaries receiving distributions from a qualified plan.  

When an individual other than the decedent's spouse receives a lump sum distribution from an IRA, in general, the individual may not roll over that distribution into another IRA, it must be distributed within a certain period [IRC §401(a)(9) 408(d)(3)].  The distribution, minus aggregate amount of non-deductible IRA contributions, is taxed as ordinary income in the year the distribution is received (Rev. Rul. 92-47).

This law does not change the rule that allows a surviving spouse to treat an inherited IRA as his or her own IRA, or to roll funds from a deceased spouse's employer-sponsored pension plan or IRA over to his or her own IRA or employer-sponsored pension plan. [IRC §402(c)(9)]

Beneficiaries of a Traditional IRA generally must receive a RMD from the inherited account for each year after the year of the IRA owner's death.  "Designated beneficiaries" (named by the IRA account owner or designated under the plan as of the date of death) as a beneficiary, may spread distributions over their life expectancy.

If you inherit your spouse's Traditional IRA and you are under 70 1/2, you may delay the start of RMDs by treating the IRA as your own.

Required Withdrawals From Your IRA

courtesy: IRS Videos

IRAs

ROTH or Traditional; Making the Smart IRA Choice
Planning for and individual retirement account (IRA) can be quite complicated. Taxpayers have several types of IRAs to choose from, all with different eligibility requirements and tax treatments to consider. In choosing the IRA that will produce the best tax and financial results for you, you should start by reviewing some IRA basics

Review traditional IRAs
Deductible: With a traditional deductible IRA, you take a tax deduction for the year that you make your contribution. Contributions and earnings grow tax-free until withdrawn, at which time they are subject to regular income tax.

Withdrawals must begin after you reach age 70 1/2, and withdrawals before age 59 1/2 are generally subject to a penalty.

If you have a company retirement plan at work and your income exceeds certain levels, you may not be eligible for a traditional deductible IRA.

Nondeductible: Contributions to a traditional nondeductible IRA do not generate a tax deduction. But once a contribution is made, nondeductible IRAs are treated much like deductible IRAs. Because contributions were not deductible, they are not taxed when eligible for withdrawal. Earnings in a nondeductible IRA grow tax free until withdrawn, and withdrawals must begin after you reach age 70 1/2.

Spousal: Nonworking spouses are allowed to contribute up to $3,000 a year to a spousal IRA. A joint return must be filed, and total IRA contributions for both spouses cannot exceed their combined earnings.

Roth IRA
With a Roth IRA, contributions are not deductible, but there is an important, offsetting benefit: principal and earnings in a Roth IRA are never again subject to tax if you meet certain requirements.

Example: You contribute $2,000 annually to a Roth IRA. Although you receive no tax deduction, this IRA can grow to any amount and it will never again be subject to tax. And for the rest of your life, withdrawals may be as large or small as desired, provided the IRA has been in existence for at least five years and you are at least 59 1/2 years old.

A Roth IRA is not subject to mandatory distribution requirements. Also, spousal Roth IRAs are permitted. Eligibility for a Roth IRA is phased out at income levels of $95,000 to $110,000 for singles and at $150,000 to $160,000 for couples.

Deductible, nondeductible, or Roth?
If you are eligible to contribute to all three types of IRAs -- deductible, nondeductible, and Roth -- you can safely ignore the nondeductible IRA, since it is clearly less attractive than the other two. But deciding between a deductible IRA and a Roth IRA can be very difficult.

If you expect your tax bracket to increase during retirement, or stay the same as it is now, a Roth IRA is probably a better choice than a deductible IRA.

But if you expect your tax bracket to be lower during retirement, or you simply do not know, you might want to opt for a deductible IRA.

When making the IRA decision, you also may need to consider other factors, such as length of time until retirement, expected rate of return on investments, and the relative amount of your IRA and non-IRA assets.

Comparison of Traditional and Roth IRAs
Assume you have decided to put $2,000 away every year for the next 20 years. You expect the account will earn an annual average rate of return of 10%, and your tax rate will be 28% before and after retirement.

Comparison: Traditional & Roth IRA's

Description                                            Traditional    Roth

Total Contribution to IRA	40,000	40,000
Accumulation in IRA ($40,000 plus 10% earnings) before taxes	126,005	126,005
Tax on IRA withdrawals	(35,281)	- 0 -
Value of IRA account  after tax	90,724	126,005
Future Value of Tax Savings Invested  [$560/year = ($2,000 x 28% tax rate) @ 7.2% yield after tax rate {10% x (1 - .28)}]	+25,155	- 0 -
Value at retirement	115,879	126,005

Conclusion: A Roth IRA may be worth $10,126 ($126,005 - $115,879)
more than a Traditional IRA.

How was this calculated?
Step 1: First we found the value of a Roth IRA if you contributed $2,000 per year for 20 years earning an assumed 10.00% per year. This equaled $126,005. Since withdrawals from a Roth IRA are not taxed, the total value remains $126,005.

Step 2: We then computed the totals for a Traditional IRA. Again we determined the value of $2,000 per year for 20 years earning an assumed 10.00% per year. This is the same amount as the Roth IRA total, $126,005. However, tax deductible contributions and all earnings in a Traditional IRA are taxable when they are withdrawn. After taxes, the value of your Traditional IRA account would be $90,724. The Roth Account value at retirement assumes you take a qualified distribution from your account. This account distribution, including any investment earnings, may be tax-free if you meet the following criteria: you are at least 59 ½ , deceased or disabled; and your first contribution to the Roth account was made at least five tax years earlier than the date of the distribution.

Step 3: Finally, if you had any tax deductible Traditional IRA contributions we need to determine the value of investing this tax savings and add this amount to the Traditional IRA total. If we forget this step, our comparison will not be equal (we would in effect be contributing more to our Roth IRA than the Traditional IRA). If your tax savings was invested for 20 years at an assumed rate of 7.2% after tax rate, this returns a total of $25,155 after taxes.

Estate Tax on Income In Respect of a Decedent

This sounds complicated, but it can save you a lot of money if you inherited an IRA from someone whose estate was big enough to be subject to the federal estate tax. Basically, you get an income-tax deduction for the amount of estate tax paid on the IRA assets you received. Let's say you inherited a $100,000 IRA, and the fact that the money was included in your benefactor's estate added $45,000 to the estate-tax bill.

You get to deduct that $45,000 on your tax returns as you withdraw the money from the IRA. If you withdraw $50,000 in one year, for example, you get to claim a $22,500 itemized deduction on Schedule A. That would save you $6,300 in the 28% bracket.