These steps will help you make the most of the bittersweet situation you are in.
Once upon a time, if you inherited a Roth IRA, you would be able to stretch the inherited Roth IRA withdrawals out over your lifetime, letting the money grow over the years. Now though, the rules have changed. With the SECURE Act, which was signed into law in December of 2019, planning for an inherited IRA requires a little bit more effort and intention.
This is because the act imposes a new rule on inherited IRAs for any account whose owner died after December 31, 2019, requiring that beneficiaries must empty the account within 10 years of the owner’s death (unless they qualify for an exception).
While this new law definitely limits what you can do with an inherited IRA, there is still some flexibility in how you reap the benefits as long as you stay in the 10-year time limit. Here are five tips to guide you as you plan your strategy.
1. Switch to an inherited Roth IRA account.
Before you begin making plans for your newfound wealth, there are some administrative steps that you have to get out of the way first. Most Importantly, you will have to move the funds from the inherited IRA into a new IRA account. If you inherited the Roth IRA from your spouse, then you can transfer the inherited funds directly into your Roth IRA account, if you have one. If not, then you’ll have to open a RothIRA and transfer the funds in. If you are inheriting the Roth IRA from someone who isn’t your spouse, you need to open a new Roth IRA account so that you can transfer the assets into that account.
When it comes to IRAs there are two main types which, while similar, are taxed differently. If you inherit a traditional IRA, you will be taxed when you withdraw from the account. If you were fortunate enough to inherit a Roth IRA, then you will most likely be able to make withdrawals tax-free. Regardless of what type of IRA you inherited, you must open the same type of account when you are getting ready to transfer over.
2. Be sure to check if you qualify for one of the exemptions.
As mentioned above, there are exceptions to the new 10-year rule. You might qualify for a different distribution timeline if:
- You’re a minor child. Though you have to begin receiving distributions from your inheritance immediately, they will be determined by life expectancy instead of on a time limit. So, any months or years you have as a beneficiary of an IRA before turning 18 won't count towards the 10-year requirement. Once you are of age, however, the clock will begin ticking on your 10-year requirement.
- The inherited IRA came from a spouse. Should the unfortunate event occur in which you are widowed and left the beneficiary of your spouse’s IRA, you are able to treat this account as if it is your own. That means for a Roth IRA you never have to take distributions out, and if it’s a traditional IRA you don’t have to take out any distributions until you are 72.
- You’re chronically ill or disabled. If this is the case, you can receive your IRA distributions at your own pace and allow them to stretch out over your lifetime.
- You’re less than 10 years younger than the account owner. Typically, this exemption is for siblings or unmarried couples who inherit an IRA from one another. However, no matter who the IRA comes from, if you were close in age with the account owner, then you qualify to stretch your IRA distributions out over your lifetime.
3. Increase Retirement Savings.
Should you not meet any of the above exceptions and find yourself with only 10 years to empty the inherited IRA account, it could be a great opportunity to ramp up your retirement savings. If you are financially stable enough that you don’t need the inherited money immediately, consider using the distributions to cover your living expenses and contributing more of your earned income to your retirement plan. If you inherited a Roth IRA, this is easier to do, as your withdrawals are not counted as income and are therefore tax-free. For traditional IRAs, you may be pushed into a higher tax bracket, so make sure to prepare your cash flow projection for the next ten years to take more distributions in the years when your income is lower to avoid causing a very high-income year in the tenth year.
Note: you must have earned income from work in order to contribute to an IRA, and your income cannot exceed the Roth IRA income limits.
4. Take advantage of the opportunity to focus on other money goals.
Once you’ve planned out a way to enhance your retirement savings, or if you’re already in a good place with your retirement planning, this newly inherited money could be a great opportunity to tackle any other financial goals you may have. You could build a solid emergency fund, pay down any debt or loans, give more to charity, or maybe even go on that trip you’ve been dreaming of.
5. Talk with a financial advisor.
Understanding the nuances of IRAs and how to make these accounts work for you can be complicated. For instance, if you’re close to retirement age, you may want to postpone collecting your Social Security benefits or retirement nest egg and live off of your inheritance for a while. Doing this would allow you to receive higher monthly Social Security benefits for the rest of your retirement. Or, if you’re young enough that retirement seems like a lifetime away, talking with a financial planner could help you prioritize and manage your inheritance along with your financial goals in order to figure out the best strategy for your inheritance.
Regardless of your age and where you are on your financial journey, talking with a trusted advisor is the best way to be sure that you’re making the most of your inherited gift. If you find yourself with a freshly inherited IRA, please contact me today to get started on creating a plan that’s perfect for your personal financial needs.