An amazing phenomenon is about to occur. Ever wonder why your great Uncle can afford that Porsche and wear Polo? Born between 1946 and 1964, baby boomers were and still are a generation that was able to accumulate immense wealth due to a strong labor market, very cheap housing and the ability to save via tax deferred funds. They are still the wealthiest generation in the world. This will soon change. As the oldest of this era starts to turn 80 years young, a shift of about $84 trillion begins. The funds will end up in the hands of their next of kin who will in turn start buying expensive AI Apple goggles, EVs, and elaborate vacation packages in Bora Bora. Along with this, one financial item many Gen Xers and Millennials will have to deal with is called an Inherited IRA (sometimes referred to as a Beneficiary IRA).
In simple terms, an inherited IRA is an individual retirement account (IRA) one opens when they are the recipient of a deceased person’s tax deferred retirement plan. Think of your great Uncle Larry who socked every penny he could into his 401k plan at the Delaware Dupont factory in the 80s. If he listed you as a beneficiary of his 401k rollover, then you must decide on what to do with this newfound wealth. Non-spouse beneficiaries can open and transfer funds into one of these Inherited IRAs, and with that, continue taking advantage of the tax deferred status it has always held. You can also take a lump-sum withdrawal which will come attached to a significant tax bill (withdrawals are generally taxed as ordinary income) or one could turn down the inheritance.
In cases where the spouse is still surviving, then he or she can simply roll those funds into an existing IRA account or start with a new IRA. If you and your siblings are the beneficiaries, you each will have to open up Inherited IRAs and then you individually can decide what you want to do with the funds. One sister may want to withdrawal all funds and pay the taxes all at once, while another may want to keep it going tax-deferred.
There is a certain item called an RMD or required minimum distribution that needs to be paid attention to. If the person who held the plan passed away after January 1, 2020 then in most cases the beneficiary must withdrawal all of the funds within 10 years. Some clients will wait until year 10 to take a lump sum while others may do smaller annual distributions. If the person who passed died before
that date, then the beneficiary can spread out the required minimum distribution over their own lifetime.
Yes, you will need a PhD in these products with so many rules the IRS has implemented.
If you inherited an account in 2020 or later and the original owner already started RMDs, you must start withdrawals immediately. If the beneficiary is not more than 10 years younger than the original account owner withdrawals can be stretched over your lifetime. The penalty is 25% of the amount that should have been withdrawn or 10% if the RMD is corrected within two years.