The rules about inherited IRAs are complex, and mistakes can be costly. These accounts need to be addressed for tax planning and in your estate plan.
Mistakes made with an inherited IRA can become very expensive, very quickly. A recent article in The Hampton Roads Business Journal, “You may be paying more tax on inherited IRA than required,” explains the basics.
IRAs are distributed differently than other assets, during life and after death. Your IRA beneficiaries may qualify for special tax breaks that are often overlooked. They can’t change ownership during life or be jointly owned. IRAs pass by contract generally, and not by a will.
IRAs may require their own estate plans, and those plans should be integrated within the overall estate plan. You should speak with your estate planning attorney about this.
As far as taxes are concerned, IRA investment gains may not be subject to the 3.8% investment income surtax and may be subject to double tax at death–both income and possibly estate tax.
For example, if you were to inherit an IRA from your father when he passes away and he has a taxable estate, as the beneficiary you may be entitled to a special deduction that can offset some of the otherwise-taxable distributions from that IRA. This deduction is easy to miss because two entities must coordinate their tax planning: (1) the settling estate and (2) the IRA beneficiary. It’s not common for these two to make a coordinated effort to realize all of the tax-saving opportunities.
The distributions from an inherited IRA are generally fully taxable to the beneficiary. You might be able to find shelter from that tax liability, which would be easier to catch before the inherited IRA begins to pay income. However, even if you’ve started to get income, you may still be entitled to take this deduction.
When an IRA owner dies, there are a few complex rules from the IRS with which you’re expected to comply. The 691(c) deduction for Income in Respect of a Decedent may be worth discussing with your estate planning attorney if you have inherited an IRA or think you may in the future. IRAs are very different when it comes to how they mesh with your existing plans and those of your heirs.
When it comes to retirement savings, IRAs are terrific, but their complexity requires the help of an experienced estate planning attorney. The goal is to pay less taxes, not more, and that takes understanding how the inherited IRA works, as well as how it fits into your overall estate plan.
Reference: The Hampton Roads Business Journal (October 30, 2017) “You may be paying more tax on inherited IRA than required”
Holden & Campbell, LLC – Annapolis Estate Planning Attorneys