New rules for inherited IRAs may be coming….
Many of you may inherit traditional IRAs from loved ones. While inheritances are usually good news there is bad news also… income taxes!!! If you decide to withdraw the money in one lump sum, then you will be taxed on ALL the income in one year. Luckily the IRS has provided favorable income tax rules if you are a “designated beneficiary” (basically an individual).
If you are a designated beneficiary, then you may be able to calculate your taxes based on a payout over your life expectancy. For example if you are 45 when your parent dies and your parent is over 70 1/2 and has been taking distributions, then you would be able to take distributions annually out over your life expectancy which, according to the IRS tables, is 38.8 years. If the death benefit is $500,000 you could distribute only $12,886 in the first year to yourself (that is the MINIMUM you can take out… you can always take out more) and you would only be taxed on such amount. Future minimum required distributions are based on a life expectancy table.
If you are in the 35% bracket you would pay $4,510 in taxes. Alternatively if you took the $500,000 distribution in a lump sum you would be paying $175,000 in taxes in one year. You may think what difference will it make because I am either paying taxes now or over 38.8 years. The difference is the income tax deferred GROWTH within the retirement plan. While your money is growing within the plan no income tax is incurred. Many experts have done charts and illustrations but trust me this income tax deferral and growth is a VERY beneficial strategy.
Like many good things in the tax laws,,, this deferral may come to an end. Congress has proposed shortening the payout period to 5 years! The policy is that inherited IRAs are not the retirement funds of the payee (the 45 year old is still working) and that was not the intent of Congress.. the intent was to use these monies only for retirement for the individual that made the money.. not to let their beneficiaries benefit from the tax free growth and deferral.
Advice: You may want to look at conversion to a Roth IRA (distributions from which are tax free) and if this law passes and you are a beneficiary of such a plan you should discuss with your tax adviser methods to reduce the tax “bite”.
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