Although people sometimes complain about taxes, the Internal Revenue Service provides some surprising tax shelters you find only under special circumstances. When a loved-one dies and you’ve inherited his IRA, the IRS gives you the option of keeping the tax shelter and slowing removing money over time as if he were still alive. Because tax brackets are punishing to people who remove large amounts of money from an IRA at one time, keeping an inherited IRA can potentially save you thousands of dollars in taxes. While the money sits inside of an inherited IRA, you should invest it for your goals.
Check the beneficiary form on the inherited IRA to ensure that you’re the sole owner. If not, ask to split the inherited IRA into separate accounts for each beneficiary to avoid investment arguments. This will allow you to invest the inherited IRA as you wish, rather than by committee.
Review tax rules. Because IRS rules force you to withdraw money from an inherited IRA, you shouldn’t enter into investments without knowing the law. If you were married to the original IRA owner, you are allowed to roll the proceeds into your own IRA and can then commingle these dollars with your own investments. Everyone other than a spouse must begin taking distributions from the inherited IRA by December 31 of the year after inheriting the account. Additionally, if the deceased was over 70 1/2, you’ll need to take his current year’s required minimum distribution before beginning your own distributions.
Calculate the tax schedule to form an investment plan. Spouses of the deceased can use their own personal tax withdrawal schedule to guide investment decisions. All other beneficiaries must take the value of the account on December 31 and divide this by their life expectancy each year as listed on the IRS “single life expectancy” table.
Research investments for your inherited IRA. Make your investment decisions based on the time until you must sell the investment to satisfy IRS requirements. Short-term goals, such as those earlier than five years, should use principal-guaranteed investments such as money markets or bonds that you can hold until maturity. Goals over five years should use bonds, stocks or other long-term investments. Stocks have historically beaten bonds over 10 year periods, while bonds are more secure for shorter-length goals.
Purchase the investments. Beginning investors often use mutual funds to purchase bonds or stocks because they offer diversification and professional management. Rather than purchasing your own securities, you can use Internet sites such as Morningstar or Yahoo! Finance to review the performance of your funds a few times a year. Funds charge fees, so review the fee schedule so you’re comfortable with how the manager is paid before purchasing your investment.
- Forbes: Five Rules For Inherited IRAs
- Financial Planning Association: Non-Spouse Inherited IRAs: How to Avoid Making Common Mistakes
- Internal Revenue Service: Publication 590: IRAs
- Financial Industry Regulatory Authority: Choosing Investments
- U.S. Securities and Exchange Commission: An Introduction to Mutual Funds
As a former financial advisor to companies and individuals for 16 years, Joe Andrews knows financial planning and marketing from start-ups to personal budgets. He also writes on motor racing, board games and travel. Andrews received his B.A. from Michigan State University in English. He is currently working on a young adult novel.