I just met with a nurse who is 52 years old. Her husband died 2 years ago just before his 50th birthday. She is working 2 jobs to put 3 teens through college.
Luckily, he left enough life insurance for her to be able to pay off the house and put a little bit of extra money into savings. She inherited his IRA and 401k plan. She has a 401k plan at work and and old IRA from another job and will have 2 pensions plus Social Security when she retires.
I'm analyzing whether she should continue to contribute to the 401k plan or use a tax-free alternative. All of her income from pensions and Social Security will be taxed. She will not have any write offs after the kids are out of school since the house is paid off.
One of her first questions to me was, "how can I reduce my income taxes?" I told her that she probably can't without taking a mortgage but it will only be worse when she retires and that is what we will focus on.
Do you know who pays the tax when an IRA is inherited? If it is inherited by the spouse, there is no tax upon inheritance. However, it will be added the to total amount counted for RMD (Required Minimum Distribution) when the spouse reaches
age 70 1/2.
If it is inherited by a person other than the spouse (son, daughter, etc.) they have a few options:
Lump Sum Distribution:
- If a beneficiary,
spouse or other person elects to take a lump sum distribution from a
inherited IRA, the disbursed money immediately becomes taxable income. IRA
proceeds are considered to be ordinary income and taxed like any other
earned income. The single distribution option is an all-in option: the
entire proceeds must be distributed and the taxes due must be paid in that
tax year.
Five-Year Payout
- An option for
non-spouse beneficiaries including individuals, the estate and trusts is
to roll the IRA into an inherited IRA. This IRA then has up to 5 years to
pay out the assets to the beneficiaries/new owners. The disbursements can
be made any time in the 5 years including waiting until the end of the
5-year period. Any distributions during the 5 years will become taxable
income to the beneficiary in the year they are received.
Required Minimum Distributions
- A non-spouse
beneficiary of an IRA can elect to have the IRA paid out in annual
installments based on the beneficiary's life expectancy. This option
allows the bulk of the IRA money to remain tax deferred over a longer
period of time. The minimum distribution option can be selected instead of
the lump sum or 5-year inherited IRA plans. The distributions must start
in the year the beneficiary inherits the IRA; at least the minimum must be
withdrawn each year and be included in the taxable income of the beneficiary.
Disclaim the IRA
- Any beneficiary
can disclaim their inheritance of an IRA. When this happens, the IRA
passes down to the next in line beneficiaries. Based on the status of
these beneficiaries, they may use one of the above-listed options to receive
or roll over funds from the IRA. The original beneficiary has 9 months
after the death of the original IRA owner to disclaim the inheritance.
This generation-skipping tactic may be used to transfer the IRA money to
beneficiaries in a lower tax bracket or to those who need the money more
without paying taxes on it twice.
