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What Happens When I Inherit an Annuity?

An advisor walking through the estate plan that includes an inherited IRA with his clients
An advisor walking through the estate plan that includes an inherited IRA with his clients

Navigating the often complex world of inherited individual retirement accounts (IRAs) can be daunting, especially in the wake of losing a loved one. It can be even more complicated if you're inheriting an already inherited IRA. Understanding the rules and regulations surrounding inheriting an inherited IRA is crucial to ensure the smooth transition of assets and to avoid potential tax pitfalls. The SECURE Act (Setting Every Community Up for Retirement Enhancement) has significantly changed the landscape, making it more important than ever to be prepared and informed. Consider working with a financial advisor about estate planning.

How an Inherited IRA Works

An inherited IRA is one that has been left to a beneficiary following the death of the original account holder. The beneficiary, or the person who inherits the IRA, can then potentially pass this on to a successor beneficiary upon his or her death. This creates the scenario of inheriting an inherited IRA.

Understanding the difference between an original beneficiary and a successor beneficiary is vital in this context and in making sure the assets are inherited. If the line of succession is not set up correctly then there is the potential for any assets being inherited to have to go through probate in order for a judge to rule on the rightful new owner.

The original beneficiary is the first person to receive the IRA after the original account holder’s death. Once the original beneficiary inherits the IRA, they can name their own beneficiary, called the successor beneficiary. The successor beneficiary then inherits the IRA upon the original beneficiary’s death. It’s essential to remember that each beneficiary must follow specific rules about distributions from the account.

How the SECURE Act Changed the Rules

The SECURE Act, enacted in late 2019, has significantly impacted the rules surrounding inherited IRAs, particularly those regarding the timeline for withdrawals. The act effectively eliminated the so-called “stretch IRA” strategy, which allowed beneficiaries to take distributions over their lifetime, stretching out the tax-deferred growth of the IRA over decades.

Under the SECURE Act, most non-spouse beneficiaries are now required to withdraw all assets from an inherited IRA within 10 years of the original account holder’s death. This change presents new implications for both the original and successor beneficiaries, particularly in regard to taxes. The impact is especially significant if the beneficiary is in their peak earning years, which may expose them to a higher tax bracket.

How to Prepare for Inheriting an Inherited IRA

Woman signs legal documents regarding her inherited IRA
Woman signs legal documents regarding her inherited IRA

Inheriting an inherited IRA can involve complex tax rules and potential pitfalls. It is crucial to understand these rules and potential tax implications to maximize the inherited assets and avoid unnecessary tax burdens. For instance, without proper planning and understanding of the rules, you could inadvertently trigger a taxable event by not taking the required distributions within the stipulated timeline.

The best way to prepare for inheriting any IRA is to first make sure that you understand your obligations and the rules surrounding the assets that you'll inherit. If it's a retirement account, like an IRA, then you'll want to know what you need to do once it's inherited. That can help you properly plan your finances to account for those assets.

Second, you'll want to make sure that the inheritance is properly documented so that it can avoid any potential probate. The last thing you want to do is to unexpectedly not receive assets you had been planning for so it's important to make sure that you'll be the beneficiary when the original beneficiary passes away.

Tips for Inheriting an IRA

Spouses inheriting an IRA may receive what many believe to be special treatment since they shared assets with their deceased spouse. For example, the SECURE Act does grant some leeway to spouses who inherit IRAs. Spouses have the option to treat the inherited IRA as their own, providing more flexibility in terms of distributions and potential tax implications.

Besides, it’s crucial to understand the concept of Year-of-Death Required Distributions. For example, suppose the original account holder was over a certain age at the time of death. In that case, a required minimum distribution (RMD) may still need to be taken out in the year of death, which may affect your tax for that year if not handled properly.

Knowing potential tax breaks related to inherited IRAs can also aid in better financial management. For instance, non-spouse beneficiaries can deduct the estate tax paid on IRA assets when calculating their income tax. You may want to consider working with an experienced tax professional to make sure you're properly planning ahead.

Bottom Line

A man explaining how to inherit an IRA
A man explaining how to inherit an IRA

Inheriting an inherited IRA can be a complex process filled with numerous rules and potential tax implications. Staying informed and prepared can better equip you to navigate the complexities of inheriting an IRA. Through understanding and strategic planning, it’s possible to maximize the benefits of inherited assets and avoid unnecessary tax burdens.

Tips for Estate Planning

  • In order to make sure you're either correctly listed as a beneficiary to certain assets, or you want to solidify your own estate plan, a financial advisor can help. Finding a financial advisor doesn't have to be hard. SmartAsset's free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now.

  • When going about creating your estate plan, consider using SmartAsset's free estate planning checklist to make sure you've covered everything that's needed.

Photo credit: ©iStock.com/kate_sept2004, ©iStock.com/FG Trade Latin, ©iStock.com/Paperkites

The post Inheriting an Inherited IRA: What You Need to Know appeared first on SmartReads by SmartAsset.

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