The only person who can take a deceased person's IRA and roll it over to their own IRA is a surviving spouse. Your kids and grandkids can’t do this, but non-spouse beneficiaries like your kids can move the deceased person’s IRA over to a special account called an Inherited IRA.
The biggest difference between an Inherited IRA and a regular IRA is that with the Inherited IRA, in most cases you now have to remove all the money from it by the end of the 10th year after the deceased IRA owner passes away.
This results in larger average taxable distributions than if you were able to take the distributions out over your life expectancy, like it used to be before the recently passed SECURE Act. The good news is you only have a required minimum distribution in the 10th year. In years 1 to 9, you can take as little or as much as you want out of the IRA.
This requires careful planning to make sure that after your kids inherit your IRA that they take the biggest withdrawals in year when they’re in the lowest tax brackets and not just blindingly waiting until the 10th year and pull it all out when they make you do it and get clobbered with taxes.
An inherited IRA is a gift from the IRS because it allows you to take the money out in the most tax efficient manner possible over a 10 year period instead of just pulling it all out at once. This can be an opportunity to really reduce the taxes on the IRA withdrawals.
Keep in mind that less than 10% of non-spouse beneficiaries like your kids elect an inherited IRA. This means that in most cases they are cashing out their parent’s IRA after inheriting it and triggering huge tax losses since all the tax is due in one year if you cash them out. Plus they lose out on what that money could have grown to if they had stretched it over the 10 year period and taken the withdrawals in a tax efficient manner.
For example, Bobby’s mom passes away, and Bobby is the beneficiary of her $200,000 IRA. Bobby gets a call from the financial institution where his mom had the IRA and the clerk tells Bobby: honey, I'm sorry to hear about your mom, but I have a bit of good news for you, your mom left you a $200,000 IRA.
All Bobby hears is $200,000! Bobby's eyes get as big as saucers and he says four words to the IRA custodian clerk on the other end of the line: Send me the money!
They liquidate the IRA, send Bobby a check, and boom, Bobby gets $200,000 of pure taxable income dumped in his lap on top of any other income Bobby was making from his job! Depending on his tax bracket, he could lose up to almost $75,000 in taxes!
The moral of the story is if you’re leaving money to your kids in a pre-tax IRA, make sure they understand what an Inherited IRA is and how to get one set up when inheriting their parents’ IRA. If Parents want to force this election on their kids, they can pursue setting up an Inherited IRA Trust while they are still alive.
The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security.