required minimum distribution retirement resource for caregiversLast month, in Caregiver Cheat Sheet: Required Minimum Distribution and You, Part I, we discussed Required Minimum Distributions from IRA retirement savings accounts. Money is deposited ‘pre-tax’ in an IRA account, accumulates tax-deferred, but is taxed when you withdraw it once you retire. Planning how you will disburse the funds in your self-directed IRA is an important part of retirement planning and spending, and the tax rules are especially complex. When you or a loved one inherit an IRA, however, the rules about when and how you access the money are even more complicated. Whether you are a caregiver who participates in a loved one’s finances, or you want to know for yourself, you need to know the ground rules. Last month, we talked about self-directed traditional and Roth IRAs, and how to navigate their payout. This month, we will talk about Inherited IRAs and how to avoid penalties, deadlines, and any possible tax complications.

The main difference between the RMD of a self-directed IRA and an inherited IRA is that the clock starts upon the death of the original owner, not the year that the inheritor turns 70 ½. Understandably, because the heir to an inherited IRA isn’t always a person. The best way to classify inherited IRAs is by the beneficiary, which come in three categories: the spouse heir; the non-spouse heir, such as child, sibling, or friend; and the entity heir, such as a trust, estate or non-profit organization. Naturally, a different rule about Required Minimum Distributions applies to each type of beneficiary. The one constant, except when it’s not, is that they must begin the year after the year of the original owner’s death.

If you inherit an IRA from your spouse, you have four options:

  1. Roll over the assets into a new or existing IRA in your own name (this option is only available to spouses): if your spouse was 70 ½ or older, then you may have to start taking the RMD
  2. Transfer the assets to an inherited IRA: this gives you earlier access to the funds without some of the penalties
  3. Roll over the assets into a new or existing IRA, and then convert it to a Roth IRA: you will pay taxes now, when converting, but not later, when withdrawing
  4. Disclaim – or renounce the inheritance – all or part of the IRA: then the assets would pass to the IRA’s contingency beneficiaries, usually children or grandchildren. People typically do this for estate-planning reasons.

Fidelity has an excellent guide to the rules around inheriting an IRA from a spouse, which offers much more detail than is outlined above. Be sure to do your research before making any decisions!

If you inherit an IRA, or a share of an IRA, from a parent, sibling or friend, your life is much simpler. You have to directly roll over the inherited IRA into an Inherited IRA in your own name, and use your own age (not the original owner’s date of death) to calculate the amount of the RMD. If you are one of two or more beneficiaries, then you must set your Inherited IRA up by December 31 of the year after the year of death. If you don’t, you will still have to take the RMD, and base the amount on the age of the oldest beneficiary.

If you inherit a Roth IRA, you must rollover into an Inherited Roth IRA, and you must start taking the RMD in the same way as someone who inherited a traditional IRA from a parent, sibling or friend. The main difference is that if the money has been in a Roth IRA for more than 5 years, the RMD is tax-free. Fidelity has an excellent summary of the rules for a non-spouse beneficiary, as well as examples of how to calculate the RMD.

If a trust or other entity inherits an IRA, distribution is much simpler. If the original owner was still living on April 1 of the year he or she turned 70 ½, then the RMD is based on the age of the owner (as though they were still alive). If he or she was younger than 70 ½, then the beneficiary has to withdraw all the money by the last day of the fifth year after the original owner’s death. Naturally, there is an exception to this, so be sure to talk to a real tax expert before doing anything you can’t undo.

The retirement years can be full of joy, but they can also present some difficult decisions. Caregivers and loved ones alike need to be aware of all the tax implications of when, where and how they are saving and then spending their money. An IRA is a great savings tool, but like any powerful tool, it requires respect when used. Read Casa Companion Homecare Solutions’ Caregivers Cheat Sheet: Required Minimum Distribution and You, Part I to learn about self-directed IRAs.