Deciding What to Do with Inherited IRAs

An inheritance can come at a time when you are already overwhelmed with life decisions and the loss of a loved one. On top of everything else that is going on, you need to make a big decision about the accounts you inherited.

The IRS wants you to move the money out of the current account, and you have four basic choices:

  1. The Life Expectancy Method – Spread the distributions out across your projected life expectancy, with the requirement that you take out a minimum amount every year.
  2. The Five-Year Method – Distribute everything in the next five years, with the freedom to take the money out whenever you want in that period as long as the account is empty when five years is up.
  3. The Lump Sum Method – Take the full value out now as a lump sum distribution.
  4. The Spousal Transfer – If you are the deceased’s spouse, you can transfer the assets into your own IRA (Individual Retirement Account).

There are a number of factors, but the choice really comes down to how and when you are going to use the money.

Understanding Your Options

The Life Expectancy Method allows you the most time, but grants the least flexibility. You have the rest of your life to use the money, but you need to take a required minimum distribution each year — an amount which is based on the account value at the end of the previous year and your assumed remaining years of life expectancy. As you can imagine, the IRS has their own life expectancy tables (they have tables for everything).

Take a look at the Single Life Expectancy table on page 42 of Publication 590-B . This is used — along with the account value at the end of the previous year — to calculate the minimum amount you’ll need to take out in the current year. This means that the minimum distribution can change from year to year. If the market has a great year, you may need to take out more the following year. If the market doesn’t do so hot — or you take a lot of money out of the account one year — you may not be forced to take out so much the next year. Note that the minimum distribution is just that – a minimum. You can use as much of the account as you’d like at any time.

With the Five-Year Method, what you lose in time, you gain in flexibility. You only get five years after the account holder dies to use the money from the inherited IRA, but there are no restrictions on the amounts that you can take out in any year. This is, by far, the simpler of the first two methods. Don’t get me wrong — I didn’t say better, just simpler. “Better” is a purely relative term in this case that depends on your unique situation. This method gives you the flexibility to decide exactly how you want to take the distributions as long as you empty the account within the five year window.

Emptying the account immediately — the Lump Sum Method — is probably the option most people will want to avoid. Even if you want to take the lump sum distribution, you should consider using one of the other options. You’ll still be able to take all of the money out in a couple of months, but you’ll have some additional time to absorb everything and take your time with the decision and planning. You’ll still have access to the money, but you will also have the flexibility to spread things out if you would like.

If you are the deceased’s spouse, you can take advantage of the Spousal Transfer and bring the assets into an IRA in your name. This is a great option if you don’t plan to use the money until after you retire. If you are not the deceased’s spouse, you will have to choose one of the other three options as this one is not available to you.

Deciding Which Method to Use

The first part of the decision starts with what type of IRA the money is in. If the account is a Roth IRA, then — assuming the account has been open for more than 5 years — you have no tax consequences and will probably want to stretch out your distributions as much as possible.

If the account is a traditional IRA, the decision is a little more convoluted. If the account holder was older than 70½ and not your spouse, then you will need to either use the Life Expectancy or Lump Sum Method. Once required minimum distributions (RMDs) have started coming out of an account, the IRS wants to make sure they keep coming out of the account.

If the account holder was not already 70½, then you have more flexibility. You will be able to use any of the methods described above, so you need to decide what type of flexibility is most important. The Five-Year Method gives you more flexibility but a hard deadline. The Life Expectancy Method gives you more time, but less flexibility.

You will not need to worry about the ten percent early withdrawal penalty for any of these options, but the distributions will be treated as taxable income. It is important to note that the money simply needs to leave the inherited account. Once it is out of the original account, it can be used however you would like, including reinvesting the money in another investment account.

There are a lot of facets to dealing with an inherited IRA and, as I said before, the best option depends on your individual set of circumstances, so you will likely want to speak with your financial professional about the decision.


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