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Just say ‘no’ to inherited IRA

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in Small Business Tax

Suppose you’re in line to inherit an IRA from an elderly family member, like a parent.

Strategy: If it suits your purposes, disclaim the inherited IRA. Use a “qualified disclaimer” before the transfer ever occurs.

As a result, the IRA goes to the next designated beneficiaries in line (e.g., children or grandchildren), bypassing you entirely. This estate planning move can be beneficial to someone who doesn’t need the IRA funds.

Here’s the whole story: A qualified disclaimer is a legal document whereby you waive your rights to receive money or property. When you use a disclaimer for an IRA, it’s as if you never had any rights to the money. Instead, your share of the IRA is redirected to the contingent beneficiaries named on the decedent’s IRA form. If no designation has been made, state law controls.

For most taxpayers, there are two main reasons for looking this gift horse in the mouth:

1. You don’t need the money and were eventually going to leave it to the younger generation anyway. This gives them access to the funds sooner and allows the IRA’s tax advantages to be stretched out. Because annual required minimum distributions from IRAs are based on the life expectancies of the beneficiaries, the IRA’s tax benefits will last longer if you disclaim your share in favor of one or more younger beneficiaries who have longer life expectancies.

2. The family saves tax overall. If you simply inherit the IRA, distributions will generally be taxed at your top ordinary income tax rate, which can currently be as high as 39.6%. Plus, this may cause additional tax complications because your adjusted gross income is raised. Conversely, the younger family members such as your children and/or grandchildren are likely to be in lower tax brackets.

To be legally valid, the disclaimer must:

  • Be irrevocable
  • Be in writing and include a declaration and signature of the disclaiming person
  • Identify the property, or interest in property, that is being disclaimed
  • Be delivered to the person or entity responsible for transferring the assets (e.g., the IRA custodian or trustee)
  • Be written less than nine months after the property was transferred or within nine months of the disclaiming person reaching age 21, if that’s sooner
  • Pass the assets without any direction from the person making the disclaimer.

With an IRA, the deadline for eliminating a disclaiming beneficiary (you in our example) for required minimum distribution purposes is

Sept. 30 of the year following the year of the account owner’s death. Don’t leave this to chance. Hire an estate planning pro to ensure that the disclaimer satisfies all the technicalities, taking into account any special wrinkles under state law.

Tip: Check that the contingent beneficiaries are who you think they are. Once you disclaim, you can’t recover your share of the IRA.

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