Inherited Retirement Accounts: 5 Things You Need to Know

Inherited Retirement Accounts: 5 Things You Need to Know

June 04, 2024

Inheriting assets from a loved one can be both a blessing and a responsibility. When it comes to retirement accounts, such as 401(k)s, IRAs, or pension plans, inheriting these assets carries its own set of rules and considerations. Understanding how to navigate the complexities of inherited retirement accounts is crucial to ensure you make informed decisions that align with your financial goals and obligations.

Spousal Options: If you inherit an IRA from your spouse, you have the most flexibility with respect to this account. You may treat the account as your own or consolidate it with an existing retirement account in your name. As a spouse, you may maintain the account’s tax-shelter advantage, allowing you to delay Required Minimum Distributions (RMDs) until you attain age 73.

Non-Spousal Options: If you inherit an IRA as a non-spousal beneficiary, generally, you must distribute the assets held within the inherited IRA within a specific time frame. Non-spousal beneficiaries of an inherited retirement account whose owner passed away prior to 2019 are allowed to “stretch” the withdrawals over their own life expectancy, thus spreading the tax liability over a number of years. If the inherited retirement account owner passes away after 2019, a non-spousal beneficiary typically has ten years after the year in which the account owner passes to distribute all of the assets from the account.

Roth vs. Traditional: Whether the inherited retirement account is considered a Traditional or Roth account determines the tax liability for the beneficiary. Traditional retirement accounts are funded on a pre-tax basis. This means that the funds within this type of account have never been taxed. When beneficiaries of these accounts make a withdrawal, taxes are owed at the beneficiary’s ordinary income tax rate. On the other hand, Roth retirement accounts were funded with after-tax dollars, and therefore, beneficiaries of Roth retirement accounts can take distributions without owing any tax. Thus, Roth accounts are an attractive planning tool for those who aim to pass wealth to the next generation with the least tax implications possible.

Beneficiary Designation Matters: Retirement accounts are beneficiary-driven, meaning whoever is named as beneficiary on the account supersedes what is written in one’s will. Therefore, it is critical to ensure that your beneficiary designations are up-to-date and reflective of your wishes. Naming a beneficiary also ensures that this asset will pass directly and efficiently to your beneficiary by avoiding the probate process while saving time and money otherwise spent on probate costs. Life milestones like births, marriages, deaths, or divorce should prompt you to review your beneficiaries, ensuring they align with your wishes.

Seek Professional Guidance: Inherited retirement accounts can be subject to a myriad of rules and regulations that vary depending on factors such as the type of account and the relationship between the original account owner and the beneficiary. By consulting a financial advisor and/or tax professional, you gain access to expertise that can help you navigate these complexities with confidence and clarity. A qualified professional can assess your individual circumstances, explain the tax consequences of different withdrawal options, and help you devise a strategy tailored to your specific financial goals and needs. The expertise ad support provided by a financial advisor can provide peace of mind and help you make the most of your inherited retirement assets.

Gottfried & Somberg Wealth Management does not provide legal or tax advice. Please consult a legal or tax professional regarding your individual situation.

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