Personal Finance

Money Matters: Couple seeks advice on accessing IRA inheritance

Q. I just found out I’m going to inherit a portion of Mimi’s (my Grandmother’s) IRA. It may not sound like a lot to many people but it’s a pretty large amount to me. My husband and I both have student loans and we think it would be a good idea and something of which Mimi would approve to pay off our loans. From my understanding, my portion (before the market tanked this month) will be about $75,000. Between us we have about $70,000 in student loans and the interest is a crazy 7 to 8 percent. We figure we can pay off the loans and still have a nice amount for a vacation before we start a family. How do we even get this money from Mimi’s IRA to us?

A. You are right, that is a lot of money, especially at your age. Your Mimi must have loved you very much and thought a lot of you to leave you such a nice inheritance. I’m glad you are seeking advice before acting. You may want to hire a fee-only adviser for an hour of their time to make sure you understand your options, tax consequences and make sure you have the money invested appropriately for your age. The following information will answer some of your questions and hopefully convince you not to proceed with your plan.

As a beneficiary of your Mimi’s IRA you will have what is referred to as a non-spouse inherited IRA. To receive your designated share of the IRA you must establish an Inherited IRA account. The easiest way to do this is to first establish one at the same financial institution the deceased IRA owner (Mimi in your case) used for their IRA. The application will usually ask for the deceased owners name, date of death, last four digits of their social security number and a death certificate. The person handling Mimi’s estate should be able to provide this information. You will then provide your personal information. You will also be ask to designate a beneficiary that the account will pass to if you should die while there is still money in the inherited IRA.

Once your inherited IRA is established and funded, you can do the following:

1) Open an inherited IRA account at another financial institution ( credit union, bank or brokerage) and transfer to that IRA – you could transfer cash by selling the inherited assets or transfer the assets “in kind” to the other institution (if they accept them).

2) You can leave it with the same custodian Mimi used in the same investments and/or change investments at the custodian.

3) Once the IRA is funded you could request all investments be sold and moved to cash and the money be sent to you. If you do this, you will pay taxes on the entire amount and may bump yourself into a higher tax bracket. More on this below.

You can’t add or combine an Inherited IRA with any other IRAs (unless from the same deceased owner). You MUST take a required minimum distribution (RMD) from the IRA each year beginning the year after the original IRA owner’s death by December 31st. The RMD amount is calculated using the IRS beneficiary life expectancy table and your age. If you don’t take your RMD you will be charged a 50 percent IRA penalty and still owe income tax on the amount you should have taken. You can always take more than the RMD but not less without penalty. You can ask the custodian to withhold federal and state income tax or not – unless your state requires it (North Carolina requires 4 percent).

Two problems with your plan. 1) If you cash out the entire IRA you will pay at least 15 percent federal income tax on that amount, likely 25 percent or more plus state income tax. At least $10,500 would go to Federal tax leaving you with $59,500 or less after tax. If you pay off your student loans from where will the money to pay taxes owed come? 2) This is an inheritance. It’s yours, not marital property – marital property is split 50/50 in divorce while inheritance is yours. In the unlikely but possible event of divorce, if you co-mingle the RMDs/distributions by paying off loans, into house projects, or into a joint account, etc. it may become marital property.

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