Recently, a client came to us with a question about an inheritance. Turns out, his mother left to him her IRA, which was valued at close to $1 million. His question? “Now what?” He didn’t want to make a wrong choice that could lead to a huge tax bill and he sure didn’t want to make a wrong move that could result in a poor financial move with the money his parents worked hard to save throughout their lives. He was unsure if it was even a good idea to request a check. This was a smart move. By taking a step back and seeking a bit of legal guidance, he was able to make the best choice that would allow him to enjoy the benefits of his financial windfall. “Mom was always very careful with her money. I know she’s looking down and smiling,” he said to us.
So, with our client’s mother in mind, here are a few tips that we encourage everyone to remember.
Don’t request a cash-out. The income tax repercussions can be massive and besides, there are many better options that are actually easier. If you opt for a lump sum distribution, you could lose out on the smarter opportunity of seeing it grow and you’ll definitely feel the pain of the tax man. In fact, with this amount of money, you could find yourself in the highest tax bracket, which is currently 45 percent. On $1 million, that means you’re paying Uncle Sam a whopping $450K!
Under the current IRA beneficiary rules, you aren’t afforded the option of adding this to your own IRA. What you can do, however, is incorporate a direct “trustee to trustee” transfer. You are then able to withdraw an amount every year over the course of your life. If, however, you want the money faster, say, over a ten year period, you can request a specific payout for each of those ten years. In either scenario, you will see the account continue to appreciate and you’ll also appreciate the income tax deferment too.
Anytime there are tax laws involved, it can become a bit overwhelming and even confusing. Many years ago, a client came in with her 14 year old granddaughter. I noticed her granddaughter had whispered something in her ear during the meeting. Grandma laughed and said, “Lord, this girl thinks the IRS is going to pay us!” Of course, that’s wishful thinking and no adult would make that mistake, but that doesn’t mean these laws make sense all the time, either.
The rules for inherited IRAs are very complicated. Depending on the circumstances, different rules may apply. If the rules are not properly followed, the IRA beneficiary may end up paying higher taxes or penalties, not to mention the risk of losing the opportunity for the tax advantages that do exist. It’s important to speak with a qualified estate planning attorney so that you can make the most of your inheritance and in a way that would make any mother proud.