Six Inherited IRA Mistakes That Will Destroy Your Inheritance. Let’s be honest. Stress doesn’t help us make smart financial decisions. I think it’s fair to say when we are inheriting money it’s often a busy, hectic and stressful time in our lives. Here are a few mistakes you want to avoid if you inherit an IRA or other retirement accounts from a loved one. Follow this inherited IRA advice to avoid having your inheritance crushed by taxes. Less stress, more money- sounds like a win-win to me.

 What to do with an Inherited 401(k) or Inherited IRA

Some retirement account mistakes can be fixed. On the other hand, if you make a mistake with an inherited IRA, it will be an extremely expensive lesson to learn. Likely, there will be no way to correct these mistakes or take the sting out of the sky-high cost from the taxman. Mistakes like these are most likely to happen when an IRA owner passes away and leaves his or her IRA to someone other than a spouse or a non-profit organization. In cases like these, we are talking about beneficiaries like a child, grandchild, sibling, or just someone they really liked.

The rules for Inherited IRA regardless of what type of account you are inheriting.  Whether an IRA, ROTH IRA, 401(k) Plan, Profit Sharing Plan, or even the cash value on a pension plan.  Take our Inherited IRA advice and don’t crush your inheritance. The process can be stressful. You may feel like you are dealing with idiots. A client of mine played me a voicemail saying “We at (firm name) didn’t get the fax that you sent us. Can you fax it again?”  How did they know to call her if they didn’t receive the fax? We repeated the cycle about 20 times. All the while the old firm was collecting astronomical fees.  You don’t deserve to be put through these hoops. Or the added stress of bad inherited IRA advice.

Let’s look at some of the most common, non-spouse IRA beneficiary errors that can ruin your Inherited IRA.

Ineligible Inherited IRA Rollovers

If you are a non-spouse beneficiary, you are not allowed to do an indirect rollover.  What exactly is an indirect rollover, you ask? This type of rollover takes place when the account holder transfers assets from one qualified retirement account to another.  In this situation, the account holder is responsible for ensuring that the money is transferred from one account to another.  The must all happen within a 60-day window.  If more than 60 days pass from the withdrawal then taxes will be due on the distribution along with an early withdrawal penalty of 10% if the account holder is younger than 59 ½. Again, a spouse inheriting an IRA can also do this but a non-spouse beneficiary CANNOT do this type of rollover.

As a non-spouse IRA beneficiary, you are only allowed to do a direct transfer to a properly title Inherited IRA without being taxed. If you make the mistake of withdrawing the funds, they will be taxable.  Worse,  the ability to create a stretch IRA will be lost. This potentially hugely expensive mistake cannot be reversed. The IRS has no ability to provide relief here. If inherited IRA funds are to be transferred or moved, the funds must be transferred directly being the two accounts. You should not take hold of the money at any time. If nothing else remember this piece of inherited IRA advice.

Inherited IRA Advice – Defer Taxes as long as possible

Update: The Former President Eliminated the Strech IRA with his Tax Plan in 2017-  Now there are new limits depending on who inherits an IRA.  Talk with your fabulous financial planner about how to minimize the taxes on your Inheritance.  You can still spread out your withdrawals from an Inherited IRA to keep more of your inheritance.

Stretching the IRA allows you to make withdrawals over time. In essence, this allows you to stretch the taxation over several years thereby ideally lowering the overall taxes paid on your inheritance. At the same time, it gives you the ability to enjoy tax deferral for a longer period of time on the IRA account balance.  This will be the goal for most people who inherit an IRA of any size.

Not Titling the New Inherited IRA Accounts Properly

How you title an Inherited IRA is more complicated than setting up a traditional IRA for yourself. The decedent must appear in the account title.  It should also indicate that it is an inherited or beneficiary IRA. A titling sample might read “Rich Uncle (Deceased 2/25/2018), IRA, FBO Lucky Niece, Beneficiary.”  Improper titling could result in mistakes with the account. Or you could get confused and treat it as your own personal IRA. These types of mistakes could nullify the entire Inherited IRA and result in a whopping tax bill. Picture the entire balance being taxable in a single year, on top of your regular income. Great for the IRS, terrible for your finances.

Contributing to an Inherited IRA Is A No No

People are busy, get confused and send money to the wrong accounts. It happens. Remember, you cannot contribute to an Inherited IRA. Once this happens, it will no longer be considered an Inherited IRA.  It will be treated as the beneficiary’s IRA and all of the inherited money will become taxable.

Picture it- Inherited IRA mistake

You inherit a million-dollar IRA. You are feeling flush and want to lower your own tax bill with say a $6,000 tax deductible contribution to your personal IRA. Instead, the money is mistakenly deposited into your Inherited IRA. If your investment firm doesn’t catch the mistake, and I wouldn’t count on them to catch the mistake, you just voided your Inherited IRA and the entire $1,000,000 balance would become taxable. A mistake like this would push you into the highest tax brackets. This one mistake could easily cost you $370,000 in federal taxes. Not to mention state taxes. OUCH.  In California, this could mean an additional $133,000 in State Income Taxes.

Forgetting to Take Required Minimum Distributions from your Inherited IRA

You might think, I’m in my forties (enter age here)  so I don’t need to think about the Required Minimum Distributions (RMD). For your own retirement accounts, you would be correct but the rules are different for Inherited IRAs.

RMDs on an Inherited IRA and an Inherited ROTH IRA generally begin in the year after the death of the original IRA owner. All the time I hear, “Someone told me I didn’t have to take money out until I was 72.” Because of this, people also assume the RMD requirement for Inherited ROTH IRAs are the same as non-inherited ROTH IRAs.  Sadly they are not. You will need to take RMDs from your Inherited IRA and your Inherited ROTH IRA.

Stretch IRA mistakes to avoid

Update: There is a 10-Year Rule for Inherited IRAs replacing the Stretch IRA for many beneficiaries.  Spouses who inherit an IRA can rollover the Inherited Retirement account into their own account.  Other beneficiaries will likely have to withdrawal of all the money from the Inherited IRA within 10-years.

To be eligible for a Stretch IRA you must be the designated beneficiary of a retirement account. This is the person who was actually named on the beneficiary form of the account. Not every non-spouse beneficiary will be able to do the Stretch IRA. If you ended up with the account via will, or some provision in the IRA custodial agreement when no beneficiary was expressly named – you will not have the option to take withdrawals over your full lifetime.

If you are the inheriting beneficiary through the estate, you will not necessarily be required to take a lump sum. You may have options. The RMDs will be based on when the original IRA owner passed away. If the decedent passed away before RMDs were required to begin, then the entire IRA would have to be paid out by the end of the fifth year after of the decedent’s passing. This is often called the Five-Year rule.  If the IRA owner dies after RMDs had begun the beneficiary would need to take RMDs based on the IRA owner’s remaining life expectancy as if the decedent had not died.

You don’t have to keep your Parents Old School Financial Adviser

Something like 90% of people who receive an inheritance does not keep their parents financial advisor.  So if you choose to find another financial planner that will better suit your personal financial needs you will not be alone.  This is a great time to find a fee-only Fiduciary Financial Planner.  Ditch the out-of-date Stock Broker. The investment choices that were appropriate for your parents are likely not the same investments that will help you reach your personal financial goals. I often see Inherited IRAs full of high fee mutual funds. You can often save yourself thousands of dollars in fees alone per with this quick piece of Inherited IRA advice.  Look for an independent fiduciary Financial Planner that can help you make the most of your inheritance. They can also help review your investment fees.

Take a deep breath. These mistakes are common but with a little help are easily avoided. Take your time, double-check what you are doing and don’t be afraid to reach out for help.  The costs are too high to risk a costly mistake especially because they can’t be reversed. Work with your CPA and financial planner to make sure you are maximizing your windfall and minimizing your tax bill.

 Great Inherited IRA advice will maximize the value of your inheritance. Live for Today, Plan For a Richer Tomorrow.

DAVID RAE, CFP^®, AIF^® is a Los Angeles retirement planning specialist with DRM Wealth Management. He has been helping friends of the LGBT community reach their financial goals for over a decade. Nightline has called him a “Tax Wizard in an Expensive Suit” He is a regular contributor to the Advocate Magazine, Forbes.com,  Investopedia, and Huffington Post as well as the author of the Financial Planner Los Angeles Blog. Follow him on Facebook or via his website www.davidraefp.com.

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