If you’ve just inherited an IRA, annuity, stocks, bonds, or other assets from your parents, minimizing your tax obligation is paramount. What do you need to know to keep Uncle Sam from taking more than his share when you file your tax return? In this three-part series, Attorney Franklin Drazen covers a few of the basics. This week, we look at Individual Retirement Accounts, or IRAs.
Inherited retirement accounts like IRAs and annuities and assets like stocks and bonds live at the tricky three-way intersection of estate planning, financial planning and tax planning. That’s why I advise my clients who’ve inherited these assets to do nothing until we’ve met to explore their options. When you inherit assets from a deceased parent, your actions will determine your tax bill. The worst thing to do is to cash out the plan, put it in your account, and then come to see me saying, “Now what?”
Though IRAs and annuities are often established to grow money on a tax-deferred basis, the way they viewed from a tax perspective is very different. This week, we look at IRAs.
IRAs, are essentially individual savings accounts where investments such as stocks, bonds and mutual funds are held, with earnings accumulating tax free until it’s time to take distributions. IRAs are defined and regulated by the IRS, which sets eligibility requirements, limits on how and when you can make contributions, take distributions, and determines the tax treatment for various the various types of IRAs.
If you inherit a parent’s traditional IRA, it’s important to remember that any distribution from an IRA account (even an inherited one) is taxed at ordinary income rates. Roth IRAs are the exception. Also, keep in mind that if you inherit a traditional IRA from a parent, you must take yearly required minimum distributions, or RMDs, based on your own life expectancy. You have to take out your first distribution by December 31 of the calendar year following the year your parent died. If you miss that date, you default back to the 5-year rule, which means that you’ll have five years after your parent died to withdraw all the funds from the account. There are certain situations where the application of these rules might yield a different results, especially when a trust is the beneficiary of the IRA account. That’s why it’s important to get timely guidance from qualified tax/financial professionals.
Another hurdle for adult children who inherit traditional IRAs is figuring out if the parent had taken his or her RMD in the year of death. If your 80 year-old father died March 15 of this year, leaving you his IRA, he probably hadn’t gotten around to taking out his distribution yet. If he didn’t take his RMD before his death that means you have to take it out before year’s end. If you don’t know about that or forget to do it, you’re liable for a penalty of 50 percent of the required distribution. This is especially problematic if your parent dies late in the year. The last day of the year is the deadline for taking that year’s RMD. So if your father died on Christmas Day and still hasn’t taken out the distribution, you may not even find out that you own the account until it’s already too late to take out that year’s distribution. In some cases, you can request a waiver of the penalty if the RMD wasn’t taken.
Also, even if you are under age 59 ½, you can make the withdrawal from your inherited retirement account without getting hit with a 10 percent early withdrawal penalty.
Sound confusing? It is. The tax law governing the transfer of assets from one generation to the next are complicated, frustrating and arcane. Fortunately for you, the professionals at Drazen Law Group are well equipped to help you develop a strategy that will make sure that family wealth ends up where your parents wanted it to be. Just give us a call at 203.877.7511.
Drazen Law Group’s legal articles are made available for educational purposes only as well as to provide general information and a general understanding of the law, not to provide legal advice. There is no attorney-client relationship created between the reader and Drazen Law Group. Drazen Law Group’s legal articles are not legal advice. Persons should not act upon this information without seeking advice from a lawyer licensed in their own state or jurisdiction. Drazen Law Group’s legal articles should not be used as a substitute for competent legal advice from a licensed professional attorney in the reader’s state or jurisdiction. Use of Drazen Law Group’s legal articles is at your own risk. The materials presented may not reflect the most current legal developments, verdicts or settlements. These materials may be changed, improved, or updated without notice. Drazen Law Group is not responsible for any errors or omissions in the content of this site or for damages arising from the use or performance of this site under any circumstances.
