Inherited IRAs: Making the Most of a Loved One’s Legacy
By Martin Brown
“We were paralyzed about what needed to be done first,” says Linda, a single mom. Cherisse, 31, is married and lives in a small town fifty miles east of Portland, Oregon: a continent away from Ft. Meyers, Florida, where the women grew up, and Linda still lives today. Both have modest incomes. Linda is a public school teacher, and Cherisse and her husband work for the state parks department.
Linda and her five-year-old son had just returned home from taking her mother out to dinner when the neighbor called to tell her that Sybil had been taken by ambulance to the hospital. She was suffering acute chest pains, and feared a heart attack. Though Sybil was able to call 911, she was unconscious when paramedics reached her. Fortunately the front door was open, and the front screen door was unlocked on that warm May night.
One of Linda’s biggest regrets is that she never had a chance to say goodbye. Sybil was pronounced dead upon arrival at the hospital. “After my father, Charles, died of cancer I don’t think Mom was ever able to get her bearings. She and Dad did everything together. I’ll always believed she died of a broken heart.”
Their parents lived modestly. “Dad invested carefully—and quite successfully.”
In fact, Charles had set up a bypass trust where, upon his death, all his wealth transferred to Sybil. And since Sybil wished to see the entire estate divided equally between her two daughters, she did the same.
Linda is the first to admit that she never gave much attention to issues surrounding her parents’ estate. “Mom asked me if she could make me the executor of her will, and of course I agreed. But she didn’t really want to talk to me about such things, so when she died, I was pretty surprised as to what their estate entailed.”
There were a variety of small cash and savings accounts to be closed and divided, but one surprise neither sister expected was an inherited IRA account that held $325,000.
Because Linda and Cherisse’s mother died in 2008, this inherited IRA comes with a smaller tax obligation.
That wasn’t always the case. Up until recently all the money received in an IRA had to be distributed over a period of five years. For Linda, who is 35, that meant she would have had to receive a distribution of $32,500 each year for a half decade: her half-share of a $325,000 IRA. This windfall, in addition to her $64,000 gross salary, would have meant a tax bite of over a third of that annual distribution. And if she had elected to take her payment as a lump sum of $162,500, she would have lost nearly 40 percent to taxes.
Now, however, under rules instituted in early 2007, many bank and employer IRA plans allow you to “step into” the position of the deceased and continue the tax deferment that the original IRA holder enjoyed during their lifetime.
In Linda’s case, this means that funds that she was required to take out over no more then a five-year period can now be withdrawn after she turns 59 and a half. After that point she must begin to withdraw funds based at least on minimum equal annual shares, determined by her remaining life expectancy, which, by the year 2032, might be an age of 90 or higher.
This is different than the rules that apply for any IRA savings account you’ve initiated for yourself, in which the required mandatory distribution begins at age 70 and a half.
Because IRA provisions can be tricky, and to not apply to all IRA accounts, you should have your financial advisor check into the status of any non-spouse IRAs in which you’ve been designated a beneficiary. And if it turns out that the controlling institution does not have a provision for a non-spouse rollover (and many do not), you and the person wishing to make the gift of an inherited IRA should consider transferring the funds to another financial institution.
Besides the tax benefits, keeping the principle in place over a period of 24 years or more will allow Linda and her sister the opportunity to earn substantial growth over the coming years. Invested wisely, their IRA amounts of $162,500 each could be worth over $400,000 when they they begin withdrawal.
Another advantage: Because the bulk of their distribution payments would come after their retirements, this should drastically lower their taxable income when they need it the most.
Thanks to the prudent savings of their parents, Linda and Cherisse should have a secure financial future. And because the investment tool they used was a beneficiary IRA, Linda’s son Christopher, should have a good start on his financial future as well.
Says Linda: “It’s a really good idea to have a licensed financial advisor that you trust. On top of everything else that your dealing with at the time you lose a loved one, you don’t also need to be figuring out how best to hold on to the money that should be going to you and not Uncle Sam.”
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