Sat, September 17, 2011
You Can’t Make An Inherited IRA Last Forever
An important aspect of Roth and traditional IRAs is that they can be inherited, with potential benefits for the heir(s). However, there are some myths afloat about inherited IRAs that need to be sunk.
Usually, the most efficient way to pass an IRA to someone is to name them as a direct beneficiary of the account. If funds remain in the account at the death of the IRA holder, under the right circumstances the beneficiary (or beneficiaries) can stretch the payout of the account’s benefits on the basis of the life expectancy of the oldest beneficiary.
For some reason, though, various myths have begun to circulate to the effect that there are ways to stretch an IRA payout over an indefinite period of time, or even to defer the payout of a Roth IRA so that it becomes a sort of perpetual investment account.
According to one scheme, leaving an IRA to a certain type of trust will allow future beneficiaries to distribute funds from the account over an indefinite period of time, enabling invested funds to accumulate tax-deferred (or in the case of a Roth IRA, tax-free) for generations. According to another, IRA distributions can be stretched out perpetually by leaving an account to a beneficiary who then dies and leaves it to another beneficiary, who dies and leaves it to another, ad infinitum.
Unfortunately, the IRS is too picky to permit either of these outcomes. In the first place, whether you put an IRA/ Roth IRA into a trust or not, the funds from either type of account must be distributed over a period of time determined by the life expectancy of the designated beneficiary. Even if the beneficiary is an infant, there is a maximum period over which the funds must be moved out of the IRA, after which the income on those funds is subject to taxation.
In the second place, suppose that you inherit an IRA and then die, passing to your own beneficiary. The distribution payout period over which funds must be emptied from that IRA is determined by YOUR life expectancy as the original “designated beneficiary.” Even if you die and leave it to someone else, the number of years of remaining payout has already been determined – it does not “reset” because someone else inherits the account. The total payout period is fixed by the life expectancy of the original designated beneficiary.
So although it would be neat to find a way to keep money accumulating tax-deferred or tax-free for generations, you can’t do it with an IRA. Not legally, anyway.