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Leaving an IRA Inheritance: What Do You Need to Know?

Retirement Planning
multigenerational family enjoys a sunny spring day as the grandparents talk about an ira inheritance

Chances are you already know about some of the advantages of individual retirement accounts (IRAs) when it comes to retirement — but how about when it comes to leaving something to your heirs? A legacy IRA, also known as an inherited IRA or an IRA inheritance, is one way to leave behind an inheritance that could help you pass on the wonderful gift of tax deferral. An inherited IRA could also be an essential part of your multigenerational wealth transfer strategy, as it gives you total control over your beneficiary or beneficiaries.

Explore the fundamentals of inherited IRAs, and discover the benefits of leaving a financial legacy for future generations.

What Is a Legacy IRA?

Let's imagine you have created a solid financial foundation for your retirement using a Roth or traditional IRA. As a result of your smart planning, you don't expect to deplete your IRA within your lifetime. Instead of spending down your IRA, you choose to draw from your savings and other investments to keep as much money in your IRA as possible.

When you pass away, the beneficiary of your IRA will then establish a new inherited IRA. If you have multiple beneficiaries, the funds in your IRA will be divided and disbursed as you've decided.

Legacy IRA Fundamentals

Inherited IRAs are treated differently than other types of IRAs, as inherited IRAs must be maintained as distinct accounts. Here's another key difference: The owner of an inherited IRA cannot postpone making withdrawals (and being taxed on those withdrawals) until he or she retires.

Your loved one will face the infamous required minimum distribution (RMD), which is an amount that must be withdrawn from the account every year. However, instead of being required to start making withdrawals by age 70 1/2, he or she will have to start making them by the end of the year following your death, and each year thereafter, according to the Internal Revenue Service (IRS).

It's important to note that Roth IRAs must have been funded at least five years before your death, according to the IRS. Also, just as you aren't taxed on what you take out of a Roth IRA in retirement, the same rule applies to distributions from an inherited Roth IRA.

The RMD will be based on your loved one's life expectancy as calculated from the year following your year of death. Suppose your beneficiary turns 50 the year after you pass (and leave them the legacy IRA). The IRS will calculate his or her life expectancy using a single life annuity table, which will predict that your beneficiary will live another 34 years or so, meaning your beneficiary's RMD will be about 1/34th of the account balance for the inherited IRA in the first year.

RMDs for inherited IRAs adjust every year — just as they do for traditional IRAs — as the beneficiary's remaining life expectancy shrinks. However, the beneficiary of your legacy IRA won't be subject to a 10 percent penalty for IRA withdrawals that begin before age 59 1/2.

Leaving a Legacy

Of course, your loved one can make larger withdrawals than the RMD. Remember: The "M" in RMD stands for "minimum" — not maximum. This means your beneficiary can withdraw the entire sum of the inherited IRA whenever he or she chooses (and face the tax consequences with non-Roth IRAs).

Chances are, however, you're hoping your loved one will be as strategic about his or her retirement savings as you were. After all, the "R" in IRA stands for "retirement." It could be helpful to discuss your wishes with your loved one, which might make them more inclined to use an inherited IRA as part of his or her own retirement saving plan.

An IRA inheritance could help you leave a legacy for your loved ones, which could also help them prepare for the road ahead. A financial representative can help you develop a plan for tomorrow — and have peace of mind for today.

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Information provided is general and educational in nature, and all products or services discussed may not be provided by Western & Southern Financial Group or its member companies (“the Company”). The information is not intended to be, and should not be construed as, legal or tax advice. The Company does not provide legal or tax advice. Laws of a specific state or laws relevant to a particular situation may affect the applicability, accuracy, or completeness of this information. Federal and state laws and regulations are complex and are subject to change. The Company makes no warranties with regard to the information or results obtained by its use. The Company disclaims any liability arising out of your use of, or reliance on, the information. Consult an attorney or tax advisor regarding your specific legal or tax situation.