It’s important to know what IRA options are available


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Mr. Gao co-found and became the CFO at Oxstones Capital Management. Mr. Gao currently serves as a director of Livedeal (Nasdaq: LIVE) and has served as a member of the Audit Committee of Livedeal since January 2012. Prior to establishing Oxstones Capital Management, from June 2008 until July 2010, Mr. Gao was a product owner at Procter and Gamble for its consolidation system and was responsible for the Procter and Gamble’s financial report consolidation process. From May 2007 to May 2008, Mr. Gao was a financial analyst at the Internal Revenue Service’s CFO division. Mr. Gao has a dual major Bachelor of Science degree in Computer Science and Economics from University of Maryland, and an M.B.A. specializing in finance and accounting from Georgetown University’s McDonough School of Business.

By THOMAS TILLEMAN, Waddell & Reed | 0 comments

One may become the recipient of assets in a variety of forms due to an inheritance. Often a retirement account, such as an Individual Retirement Account (IRA), is part of the inheritance, and it is important to know what options are available.

For review, a traditional IRA is a retirement savings vehicle that allows a taxpayer with earned income (or a spouse of the taxpayer) to deposit money into an account each year and take a deduction on the income tax return, thus reducing taxable income and providing a tax savings (please note that not everyone that deposits money into a traditional IRA will be eligible for a tax deduction).

This money continues to stay in the IRA until distributions begin (normally after age 59 1/2, which is the age the IRS allows normal withdrawals without penalty referred to as a qualified withdrawal). All of the money in the IRA (that was tax deductible) will be taxed, either to the account owner or the beneficiary (except the charitable transfers discussed in an earlier months article). Non-qualified withdrawals may be subject to income taxes and a 10 percent federal tax penalty.

This article focuses on named individuals (as opposed to a charity, an estate, or other non individuals such as a trust) as beneficiary and the options available to them upon death of the IRA account owner.

In addition, the additional options a spouse named as beneficiary would have compared to non spousal beneficiaries will be mentioned. Remember that all distributions (as long as they were tax deductible IRA contributions) to the beneficiary are subject to income tax (except spousal option listed below).

Individuals named as beneficiaries basically have four options. The first is the life expectancy option. This option allows the beneficiary to take the IRA money out over their lifetime (according to IRS life expectancy tables).

The second option allows the beneficiary to take the money out of the IRA within five years. The money can be withdrawn at any time in any amount desired as long as all is out by Dec. 31 of the fifth year anniversary of the account owner’s death.

A third option is called a lump sum distribution. This option is taking all of the money out the IRA in one payment (or all out in one year). The entire amount is taxable in the one year it is taken out, which is in contrast to the other two options listed above.

The taxes on the five-year distribution are spread out and only occur when a distribution is taken over the five years. The taxes on the lifetime distribution are spread out over the lifetime of the beneficiary as some money is taken each year (note that an IRA can continue to be “stretched” if that owner dies while taking the lifetime distribution).

Finally, a beneficiary can disclaim the money. This option is when the named beneficiary refuses to accept the money and it then passes to another beneficiary. This must be completed within nine months of the date of death.

In addition to the options described above which are available to all individual beneficiaries, a spouse named as beneficiary has additional options. The spouse can roll over the money into their own IRA, or they can put the money into an inherited IRA and then treat that money as their own account.

Neither of these options would create taxes immediately for the spouse. A taxable event would not occur until the spouse actually takes distributions from the IRA.

As always, reviewing estate, tax and retirement planning issues now can guide decisions for one’s future. As federal laws and economic conditions change, it is important to stay informed and look ahead. Consult qualified professionals to assist with all planning decisions.

(This article is meant to be general in nature and should not be construed as financial, legal or tax advice related to your personal situation. Waddell & Reed does not provide legal or tax advice so please consult a qualified professional regarding your situation prior to making any financial decision. For more detailed information please consult your advisor or call Thomas Tilleman, a Financial Advisor and Certified Financial Planner professional with Waddell & Reed at 866-576-4662. Waddell & Reed, Inc. Member SIPC.)

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