Two years ago, when Robert Garfield’s mother passed away, he and his two siblings inherited an IRA worth $300,000 through a trust. Completely unaware of the steep tax that could have come to 40% upon the transfer of funds, each planned to cash out their share in a lump sum.
When Garfield, 57, a retired doctor in Asheville, NC, consulted his financial advisor, he was shocked to learn that he could be handing over $40,000 of the $100,000 of his inheritance to the government in taxes.
“I had no clue, in any way shape or form, that I could lose that kind of money,” said Garfield.
Garfield’s financial advisor, Glen Pier of Infinity Wealth Management Inc., told him that because his mother listed her trust as the beneficiary of the IRA, her beneficiaries would be taxed at the maximum rate of 39.6%, for any amount over $12,150.
All too often, most non-spouse beneficiaries make the mistake of accepting lump sum inheritances without realizing that it often pushes you into a higher tax bracket.
“Beneficiaries are quick to put their hands on their money,” says retirement expert, Ed Slott. “But don’t touch anything until you get qualified advice. An IRA is like an eggshell. Once you break it, it’s over,” Slott says.
Upon inheriting an IRA, beneficiaries can stretch out their inheritance and avoid a big tax hit. This technique allows for non-spouse beneficiaries to leave most of the inheritance growing tax-deferred, while only taking out the required amount and minimizing what they’re taxed on each year.
How to stretch
While owners of traditional IRAs are required to take minimum distributions (RMDs) starting April 1 of the year after they reach age 70 1/2, IRA beneficiaries must take their RMDs within a year of receiving the inheritance, the amounts based on their own life expectancy and the withdrawals are taxable at local, state, and federal income tax rates.
Before Garfield’s family could make a bad move, Pier, a member of Ed Slott’s Elite Advisor Group, made sure the IRA was retitled as an "inherited IRA" so that Garfield was able to extend the life of the IRA, and only get taxed on the required minimum distribution each year.
If you have a pressing need for cash, you are allowed to take out as much as you need, says Pier, but the stretch method gives you the option to control how you’re being taxed from year to year while growing your wealth.
While the president’s 2015 budget proposal calls to eliminate the stretch IRA, retirement experts like Pier and Slott say that beneficiaries should continue to look into all of their options. “This would be a really big revenue generator the government, but Congress has not agreed on a budget in a long time," says Pier.
As for Garfield’s family, all three beneficiaries have chosen to withdraw the required minimum distribution and not take the lump sum. The total savings resulted in over $120,000 in taxes. Year after year, the check they’ll receive for their inheritance, will be a continual reminder of their mother’s legacy. “It has my mother’s name on it and it’s a nice reminder to me and my siblings that my mom still cares for us,” said Garfield.
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