What happens if you inherit an IRA from a parent?
Inheriting an Individual Retirement Account (IRA) from a parent can be both a blessing and a challenge. While it offers the opportunity to benefit from your parent’s financial planning, it also comes with certain responsibilities and tax implications. Understanding the process and the rules surrounding inherited IRAs is crucial to ensure you make the most of this inheritance.
Understanding the Inheritance
When you inherit an IRA from your parent, you become the new owner of the account. However, the rules governing inherited IRAs are different from those of traditional IRAs. It’s important to know that the value of the inherited IRA is included in your parent’s taxable estate, and you may be required to pay estate taxes depending on the size of the estate.
Types of Inherited IRAs
There are two types of inherited IRAs: a traditional IRA and a Roth IRA. The rules and tax implications for each type are different.
Traditional Inherited IRA
For a traditional IRA, you are required to take required minimum distributions (RMDs) each year. The RMDs are calculated based on your age and the value of the inherited IRA. The distributions are taxable as ordinary income. If you are named as a beneficiary on your parent’s IRA, you have several options:
1. Take RMDs annually: This is the default option, where you take out a certain percentage of the inherited IRA each year.
2. Take RMDs over your life expectancy: If you are the sole beneficiary, you can take RMDs based on your life expectancy, which can be more favorable for some individuals.
3. Transfer the inherited IRA to a new account: You can roll over the inherited IRA into a new account in your name, but this may result in higher taxes if you withdraw the funds early.
Roth Inherited IRA
For a Roth IRA, you do not have to take RMDs while you are alive. However, when you pass away, your beneficiaries will have to take RMDs based on their life expectancy. The distributions from a Roth IRA are tax-free, provided the account has been open for at least five years and the owner is at least 59½ years old.
Beneficiary Designations
It’s essential to review your parent’s IRA beneficiaries to ensure that the correct individuals are named. If you are not named as a beneficiary, you may not receive the inheritance. Additionally, you should be aware that if you are not the sole beneficiary, the rules and tax implications may be different.
Seek Professional Advice
Navigating the complexities of inherited IRAs can be challenging. It’s advisable to consult with a financial advisor or tax professional to understand the best approach for managing your inherited IRA. They can help you make informed decisions about taking distributions, rolling over the account, or transferring it to a new account.
Inheriting an IRA from a parent can provide financial security for you and your family. By understanding the rules and seeking professional advice, you can make the most of this inheritance and ensure your financial well-being.
