An individual retirement account can provide a financial foundation during your senior years if you pay into the account sufficiently throughout your working career. This being stated, if you ultimately do not need the money, it can be part of your estate plan. People often have questions about taxation and inherited individual retirement accounts, and we will provide some answers here.
There are two different types of individual retirement accounts that are typically utilized: the traditional variety, and Roth IRAs. There are some similarities between them, and there is a major difference. With a traditional individual retirement account, you make contributions into the account before you pay taxes on the income. This provides a tax benefit in the near term, because you are paying taxes on less income.
You can begin to take penalty-free withdrawals from a traditional individual retirement account when you are 59 ½ years old. If you take assets out of the account before you reach this age, there is a 10 percent penalty. However, there are some exceptions to this rule.
If you want to withdraw some of the money to make a first home purchase, you may do so without any penalties. It is also possible to take a penalty-free early withdrawal it to pay for college tuition for yourself, your spouse, your children, or your grandchildren. You can take money out of the account to pay medical bills or health insurance premiums without being penalized. A hardship exception can potentially be granted as well on a case-by-case basis. Of course, you do have to pay regular taxes on the income.
No taxes have been paid on the money that is in the individual retirement account, and the Internal Revenue Service wants to get its share eventually. For this reason, you are required to start to take mandatory minimum distributions from the IRA when you are 70 ½ years old.
Now that we have shared the basics, we can get to the matter of inheriting an individual retirement account. If the account is a traditional IRA, the inheritor would have to pay taxes on the withdrawals that are taken. When the beneficiary is not the surviving spouse of the original account holder, this beneficiary would be required to accept mandatory minimum distributions, and they would be taxed.
The amount of the mandatory minimum distributions would be tied to the age of the beneficiary, so the younger the person is, the lower the requirement would be. There is a concept called the “stretch IRA” that can be very useful under these circumstances. The beneficiary can take only the minimum that is required by law for the maximum amount of time to prolong the potential tax-deferred growth of assets that are in the individual retirement account.
When a Roth individual retirement account is being handed down, the situation is different, because assets were contributed into the account after taxes were paid. If you were to inherit a Roth IRA that was funded for at least five years before the death of the original account holder, distributions that you take from the account would not be taxed. Stretching an inherited Roth individual retirement account is even more beneficial than it is with a traditional account, because the potential growth will be distributed free of taxation.
Attend a Free Estate Planning Workshop!
We looked at one very tiny slice of the entire estate planning pie in this blog post. If you come back to visit us often, you can learn a lot more, because we are always adding new content to keep our readers informed. There are other resources on this website that you can take a look at as well, so we invite you to explore the site thoroughly.
In addition to the written material that we offer, we also provide in-person educational opportunities. Our firm is holding a number of informative estate planning workshops over the coming weeks, and you can obtain a great deal of very useful information if you attend one of the sessions. Best of all, they are being offered absolutely free of charge at the present time, so you have everything to gain and nothing to lose.
Though the workshops are being offered on a complimentary basis, we do ask that you register for the session that fits into your schedule in advance, because space is limited. To get all the details, visit our seminar schedule page.
Michael Robinson, Estate Planning Attorney
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