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I inherited an IRA from a 90 year old sister who started taking benefits before her death. I don’t need her distributions yet. Is there a more practical way I can avoid the distribution taxes on these funds right now without adding her distributions to mine at a later date? I am 86 and currently taking my own required minimum distributions (RMDs).
– Mafia boss
Inherited IRA distribution rules are so nuanced that your options aren’t necessarily obvious. I’ll start by looking at those rules so you can see what you need to navigate through. We can then talk about a few options you may want to consider for dealing with the IRA you inherited from your sister. (And if you need more help managing an inherited IRA or other assets, contact a financial advisor.)
The rules governing what a person can do with an inherited IRA are very direct. The problem is sometimes that it is not always clear which rules apply to you. It’s important to make this clear because you may have different options depending on your relationship with the deceased and whether or not they had reached the age where they were required to make minimum distributions.
I like to think of it as a flowchart. At a high level, start by considering whether you are a spouse or non-spousal beneficiary. Next, determine if you are an “eligible designated beneficiary” or “designated beneficiary.” Finally, check to see if the original account owner had already started RMDs.
Spouses are given more leeway when inheriting IRAs, with the most advantageous treatment usually being that they can simply take the IRA as their own with the same distribution rules as if it had always been their account. In other words, spousal beneficiaries do not have to begin or continue distributions.
Non-spouses, on the other hand, do not have that option. If you are not a spouse, in most cases you will most likely be required to pay out the entire balance within ten years of the person’s death. But not always. (A financial advisor can help you inherit an IRA.)
A eligible designated beneficiary could be one of the following:
Anyone who does not meet any of the above requirements is simply considered a designated beneficiary. You meet the latter requirement and are therefore an eligible designated beneficiary.
Your options then depend on whether the original account holder had already started taking RMDs. Since your sister started RMDs, you have two options:
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Take a lump sum payment
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Roll the money into an inherited IRA, then take RMDs based on whichever is longer: your life expectancy or her life expectancy at the time of her death.
Obviously, none of these options will give you the solution you want, which is avoiding taxes on your benefits. (But a financial advisor can help you manage and possibly limit your overall tax liability in retirement.)
You can’t avoid distribution taxes entirely. That’s by design, as the whole purpose of RMDs is to ensure that tax-deferred money eventually makes its way back into the wild, where it can be taxed. But you can proactively deal with it in a way that suits you best. (And if you’d like to discuss scenarios like this with a financial advisor, our free tool can connect you with one.)
Some options you may want to consider include:
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Perform a Roth conversion. You can’t convert the inherited IRA, but you can convert your own IRA to a Roth account. You’ll have to pay taxes on the conversion, but you won’t have to take any RMDs from the Roth, which will reduce your total RMDs in the future. You can even convert your entire balance and then take a larger distribution from your inherited IRA to pay the tax bill (allowing more to go into the Roth), provided there’s enough money in it.
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Give to a good cause. If you already give to charities, consider using qualified charitable distributions (QCDs). This allows you to spend your RMD on charity and avoid taxes entirely. This isn’t quite the same as simply taking the benefit and then donating cash. QCDs are not an itemized deduction and are not included in your adjusted gross income (AGI).
Unfortunately, there isn’t much you can do to avoid the RMD on your sister’s IRA, aside from QCDs. However, you may be able to reduce your RMDs in the future by taking advantage of the Roth conversion options for your account.
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A financial advisor can help you manage inherited assets, including IRAs. Finding a financial advisor does not have to be difficult. SmartAsset’s free tool matches you with up to three vetted financial advisors serving your area, and you can have a free introductory meeting with your advisors to decide which one you think is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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If you inherit an IRA and want to manage it yourself, it’s a good idea to dive deep into the rules surrounding this type of inheritance. Be sure to review our guide to the rules for inheriting traditional and Roth IRAs.
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Have an emergency fund on hand in case you encounter unexpected expenses. An emergency fund should be liquid – in an account that is not at risk of significant fluctuations like the stock market. The trade-off is that the value of liquid cash can be eroded by inflation. But with a high-interest account, you can earn compound interest. Compare savings accounts from these banks.
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Are you a financial advisor looking to grow your business? SmartAsset AMP helps advisors connect with leads and provides marketing automation solutions so you can spend more time making conversions. Learn more about SmartAsset AMP.
Brandon Renfro, CFP®, is a financial planning columnist at SmartAsset, answering reader questions about personal finance and tax topics. Do you have a question that you would like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.
Please note that Brandon is not a participant in the SmartAsset AMP platform, nor an employee of SmartAsset, and has received compensation for this article. Questions may be edited for clarity or length.
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