Without proper planning, taxes can eat away at inherited IRAs

Many Michigan residents may have an IRA that they wish to leave to their spouse or a child once they pass on. However, without proper planning, much of this inheritance could be lost to taxes. Anyone with an IRA who is in the process of estate planning should understand how tax laws will affect their heirs. Doing so may allow the inheritance to have a more positive effect on a loved one’s life.

Individual retirement accounts have a great strength over other investments. The interest, capital gains, and dividends created by these accounts grow on a tax-deferred basis. Experts say that taking advantage of this requires the account holder to leave as much money as possible inside the account. However, most of the time an IRA must be re-titled or renamed to show that it was inherited to keep these tax advantages.

A personal finance columnist for AARP Bulletin says that it is possible for heirs to stretch the benefits of an inherited IRA out over a lifetime. Allowing the IRA to continue to grow will allow an heir to get much more money from the IRA than if all the money had been taken out at once and put in their own name. Once that money is taken out and put in the beneficiaries name it gets taxed, unless the IRA is re-titled as an inherited IRA. The same goes for company 401(k) plans as well.

She says that it is important for people with IRAs to leave instructions in their wills for their children explaining how to handle inherited IRAs. Having a full understanding of what tax implications investments such as IRAs will have on your heirs is important when planning one’s estate.

Source: Pittsburgh Post-Gazette, “Planning can help avoid tax penalties and ensure growth for inherited IRAs,” Tim Grant, Nov. 8, 2012