IRAs can be inherited

October 8, 2010

Know whether your family can inherit your IRA account.

Q: Can my family inherit my traditional individual retirement account (IRA)? If so, how do I make sure it passes to them?

To do so, you must be sure to legally designate your family members as the account's beneficiaries. Also, the Internal Revenue Service mandates required minimum distributions (RMDs) from your IRA each year once you turn 70 ½ years old. The amount of the RMD is determined by a "life expectancy factor" that the IRS publishes annually. Forget to take the RMD, and you or your heirs will pay a penalty of 50% on the amount that should have been withdrawn.

Myrna, age 66, treats Harvey's IRA as her own, names her son Marc as her sole beneficiary, and over 8 years takes RMDs of $156,123 until passing away at 77. Myrna can treat Harvey's IRA as her own because she is his spouse. Once it becomes hers, she is able to delay RMDs until she turns 70 ½ years old.

Marc, age 53, maintains the account as an inherited IRA, names his son Logan as his sole beneficiary, and takes RMDs totaling $933,576 (based on his own remaining life expectancy of 32 years) over the course of 23 years until passing away at age 75.

Logan, 41, takes RMDs of $1,026,841 (based on Marc's remaining life expectancy until assets are divested) over the course of 9 years. Logan takes RMDs for 9 years because his father had taken RMDs for only 23 of his 32-year life expectancy (32-23=9). Total withdrawals are $2,139,189 over 3 generations.

To fully realize the benefit of stretching your IRA in this way, you must avoid early withdrawals. Unfortunately, some investors view their IRAs as piggy banks, breaking them open whenever unexpected expenses arise.

From a financial standpoint this is a serious mistake, one that should be avoided if at all possible. Not only do you face a 10% penalty for withdrawals (under most circumstances) before the age of 59 ½ and income taxes, but withdrawals from your IRA are difficult to replace due to IRS-mandated annual contribution limits.

So to recap: Try to delay withdrawals from your IRA until required by the IRS. Designate appropriate beneficiaries, and instruct them to withdraw at the pace required by the IRS. Take these steps, and your family can continue to reap the benefits of your IRA over multiple generations.

Send your money management questions to medec@advanstar.comAnswers to our readers' questions were provided by Aaron Skloff, AIF, CFA, MBA, chief executive officer of Skloff Finanial Group, Berkeley Heights, New Jersey.