David Lerner Associates: Inheriting a Retirement Account

“The rules are hard-and-fast, and they must be followed to the letter,” says David Lerner Associates’ Executive Vice President of Sales Martin Walcoe.

These days, the stakes can be high. “The money in a parent’s or spouse’s IRA or 401(k) can be substantial,” says Walcoe. “Some retirees tend to leave their nest egg untouched for as long as possible to avoid paying more taxes than necessary.”To avoid an expensive mistake, Walcoe urges recipients to seek help from a professional who can guide them through the estate and tax planning considerations of inheriting a retirement account.

The process is fairly straightforward if you inherited the account from a spouse, he explains. You can roll over the assets into your own IRA. With a traditional IRA, you won’t be required to touch the money until you reach age 70½ at which time you’ll need to begin taking required minimum distributions, or RMDs. With a Roth IRA, however, you don’t have to begin taking withdrawals until you actually need the money. So you can use it to cover expenses later in retirement, or leave the money to your children.

However, Walcoe advises younger spouses to consider whether or not they will need to tap some of that IRA money before age 70½. Here, he notes that surviving spouses who are under age 59½ may be able to re-title the account as an “inherited IRA” and possibly avoid the 10 percent IRS penalty assessed on early withdrawals.

For example, the IRA that Bob Smith leaves to his 53-year-old wife could be re-titled “Bob Smith IRA (deceased Oct. 1, 2012) for the benefit of Jane Smith, beneficiary.” Jane can then start withdrawing money penalty-free right away.

Those who inherit an IRA from a parent, grandparent or even a family friend have a choice between cashing out the account as a lump sum, liquidating the account within five years, or stretching the required distributions over their own life expectancy.

“The downside to taking a lump sum is that you may face a substantial tax bill,” Walcoe explains. “Any money you withdraw from a traditional IRA is added to your taxable income during the year you receive it.” Alternatively, recipients may be able to receive distributions over a longer period, which can result in distributions having a smaller effect on their annual tax bill. [There are some very specific requirements in order to be able to stretch your distributions this way. Work with a tax expert before you make any decisions to see which is the best solution for you.]

While being named the beneficiary of a loved one’s retirement account can be a financial blessing, Walcoe stresses that properly handling this windfall is essential. Because an unexpected tax bill can easily crack a retirement nest egg, and tax laws change frequently, he advises recipients to learn the rules and talk to a tax expert about their specific situation

Material contained in this article is provided for information purposes only and is not intended to be used in connection with the evaluation of any investments offered by David Lerner Associates,Inc. (DLA). This material does not constitute an offer or recommendation to buy or sell securities and should not be considering in connection with the purchase or sale of securities. Member FINRA & SIPC.