Inheriting Problems

In recent days the stock market has been going though some turmoil due to tariff-related headlines you’ve probably heard about. In the midst of an otherwise healthy economy, this latest volley in our trade war with China seems ill timed. It’s frustrating for sure, at least in part because there’s nothing we can do about it in the short term. 

Since there’s no use trying to “trade” this kind of event it’s best to remind ourselves to instead focus on controlling what can be controlled. An example of this has nothing at all to do with geopolitics and trade: avoiding some common mistakes related to inheriting IRAs. 

I recently had questions from someone, let’s call her Jane, who was inheriting three IRAs from her recently deceased grandmother. Jane wanted to know her options and the best next steps for moving accounts into her name, accessing money and so forth.

Jane inherited one of the accounts 50/50 with brother, which is pretty straightforward. IRAs, like life insurance proceeds, can go direct to whomever is listed as beneficiary. There’s no probate either, which saves time, money and lots of headaches. The other two accounts were left 100% to her.

Jane knew that her grandmother had intended for all of her retirement money to be spilt evenly between Jane and her brother. But for some reason he wasn’t a named beneficiary on the other two accounts, so he’s not directly entitled to any of that money. This obviously presents problems.

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After Jane found all this out she did some research and learned that, had she been a spouse, her options would have been much simpler (spouses get to treat inherited IRAs as they’re own). But, as a non-spouse beneficiary, she had a number of complicated options to consider.

Since all this money has been tax deferred, the government isn’t just going to let it pass to beneficiaries without taxation. Jane has to decide between taking required minimum distributions (like her grandmother had been, but based instead on Jane’s life expectancy), or face a 50% penalty.

She doesn’t have to start taking RMDs immediately, but she can’t delay for too long either. Not doing so by the end of the year following her grandmother’s death serves as an indication to the IRS that she’ll be withdrawing all the money within the next five years. And every dime is taxable.

Jane is understandably confused. Should she start taking RMDs and try to stretch out the balances for as long as possible?  Or should she plan to liquidate the account within five years? What are her own financial needs? How does her brother and her grandmother’s wishes fit into the equation?

Jane earns a modest income, so taking minimum distributions might cost her about 15% in taxes. The account she inherited with her brother is small compared with the balances on the accounts she inherited herself. Taking large distributions from those could increase her tax burden, so she has to be thoughtful to avoid getting whacked by taxes.

Ideally, Jane’s grandmother would have listed both of her grandchildren as beneficiaries on each account. Apparently she didn’t feel comfortable leaving her grandson with all the money in a lump sum. So, instead of creating a trust to handle the money for him she wanted her granddaughter do so informally. The problem, of course, is that this puts all the pressure and tax burden on Jane. 

Additionally, gifts over $15,000 are subjected to gift tax in the year given. So, Jane could gift up to that amount pretty easily. She could also pay his college tuition costs or doctor bills directly, assuming he had any, as these payments don’t count as gifts. 

This sets up a scenario where Jane could be on the hook for years until her brother’s portion is paid off. Is she willing to do so for that long? Is she going to charge him for the taxes she has to pay each year? What liability does she have to ensure the money is invested well in the meantime?

So, takeaways for Jane are that she needs to quickly ramp up her knowledge as well as seek appropriate assistance.

Takeaways for IRA owners wanting to leave accounts to someone other than their spouse include:

1) Don’t burden your loved ones unnecessarily. Be specific about who your beneficiaries are. List them by name and percentage and keep this updated over time.

2) Know that the money will be given to your beneficiaries as a lump sum. If they’re minors or you otherwise feel squeamish about dropping a pot of money in their lap, consult an estate planning attorney. You can create a trust, for example, to manage the assets for the beneficiary until they graduate from college, get married, and so forth. 

Ultimately, you can control the who, what and when as it pertains to your IRAs, but only if you plan ahead. 

Have questions? Ask me. I can help.