I inherited an IRA from my dad when he passed away. What is my best option regarding it? I'm 54 years old and plan on retiring sometime in the next 10-12 years.
Hi Rami, from your question, it sounds like you would like to save as much of your father's IRA as possible for your retirement in 10-12 years. At that point you'd be in your mid 60s. If these assumptions are correct, then a good strategy for you would be to "stretch" this inherited IRA out over the next 10 or so years by taking the minimum required distributions between now and then. This approach allows you to keep the bulk of the IRA intact until you retire.
Once you do retire, you can then continue taking the minimum amount out each year, or you can always take more as your circumstances dictate. If you go this route, make sure the account is titled properly, such as "Rami's Father IRA/Deceased 3/20/200x/ FBO Rami." FBO means for the benefit of. If the financial firm mistakenly titles the IRA in your name (Rami's IRA Rollover, for instance), then you lose the ability to stretch/defer the IRA over your remaining life expectancy and you'll likely be forced to empty out the IRA much faster than you wish. And penalties may happen also, since you are under 59 1/2. Proper IRA titling can become a real financial mess if not done correctly!
Of course, the bottom line in what is "best" for your situation depends on your unique facts and circumstances. The variables to consider are your tax rate now and expected tax rate in the future, your cash flow needs now, your investment options, current debt levels, and the amount in any emergency fund. Give this all some careful thought before you make any final decisions!
While I'm responding to this question more than a year after the fact (I was not aware of this website at the time), perhaps my answer will help anyone who reads this, going forward. Perhaps more important than how you invest the proceeds from your inheritance is how you handle the transfer of IRA assets. It is critically important that when you attempt to transfer the assets from your father's IRA, you must do a direct trustee to trustee transfer to a properly titled beneficiary IRA. Do not attempt to do an IRA rollover or let the custodian for your father's IRA issue a check for the proceeds to you personally. As a non-spouse beneficiary, you are not entitled to do an IRA rollover and attempting to do one or cashing a check made payable to you personally could inadvertently liquidate your fathers IRA and subject you to a potentially sizeable tax bill. Too often, IRA inheritors don't know this and neither do many clerical employees and even advisors at major banks and brokerage firms. As a result of their lack of knowledge in this seemingly simple, yet quite complex area, irreversible mistakes are often made, IRAs are inadvertently liquidated and excess and unnecessary taxes are too often paid. While my answer is purely mechanical, the mechanics of how you inherit an IRA are critical and will help you avoid common, costly mistakes and oversights.
It should be rolled into a non-spousal beneficiary IRA. By doing that, you can continue to defer a portion of the IRA without needing to distribute it and incur taxes. You may need some personal advice if you have not taken a distribution for each year since you inherited the IRA. If he passed this year, and you are age 54, you would need to distribute 1/30.5 (or 3.27868%) this year. Each year, you would reduce the denominator by 1, so next year you would distribute 1/29.5 (or 3.38983%).
Failing to make a required minimum distribution is subject to not only the tax that would have been due, but penalties and interest and an additional 50% penalty of the amount that was required to be taken that wasn’t taken. Very serious consequences for errors in this category.
For more information on the required distributions, see Table I, Single Life Expectancy at the IRS website: http://www.irs.gov/publications/p590/ar02.html .
My condolences on your father's passing.
Thanks for mentioning your situation and your age, that definitely helps answer the question. Since you are what is known as a "non-spouse" beneficiary, then you do not have the option of rolling your dad's IRA into your own and treating the account as your own. Instead, your options are a bit more limited, but maybe just as useful.
As the money in your dad's IRA has been sheltered from taxation for a while, the government wants its taxes on the money, and has limited the choices that you have as far as keeping it in the account, potentially growing tax deferred. Withdrawals from the IRA will be taxable to you as earned income in the year in which you receive it. If your dad made after-tax contributions to the IRA, then you get those dollars tax-free - but it comes out proportionately with each withdrawal (pro-rata).
Option 1: Withdraw all of the funds by the end of the year following your dad's death. Depending upon the size of the account and your income, this is usually the least tax-friendly option and doesn't seem to fit your situation.
Option 2: Withdraw all of the funds by the end of the 5th year following your dad's death. If you do NOT do Option 1 or Option 4 (which I'll get to), then this is pretty much the "default" option. Depending upon the size of your dad's account - and your tax bracket - this just might fit the bill. If you are in a very low tax bracket, and can withdraw the funds from your dad's account and deposit them in a regular (ie - taxable) investment account and invest very tax efficiently - this option may well be worth considering. I personally am a big fan of investment accounts that are not tax-sheltered in any way. You can use tax-free municipal bonds, or you can offset capital gains with capital losses within the portfolio to invest very tax efficiently for your future retirement plans. Again - if your dad's account is relatively small - especially if you have a large 401(k), IRA, pension plan, or similar retirement vehicle of your own - then consult with your CPA or financial advisor and give this option serious thought.
Option 4: The Stretch IRA. This option is the one that many advisors automatically jump on, but typically works best if the inherited IRA is very large. Essentially, what happens is this: You begin withdrawals from the IRA based upon YOUR life expectancy. Your first withdrawal MUST be done by December 31st of the year following your dad's death. If you do NOT make this withdrawal in time, then you lose this option forever and you are stuck with Option 2. You can find the required minimum distribution schedule in IRS Publication 590; refer to Table 1 for the amount you must withdraw from the IRA each year. This option allows you to keep the majority of the account growing tax-deferred, and can create a sizeable nest egg for your own retirement. Pay particular attention to the dates in Pub 590!!! If you do not take the first distribution in time, then you lose this option and must deplete the entire IRA within 5 years.
One of the topics that was not focused on in the answers to this question is the portfolio management or investment side of inheriting an IRA from a parent. The brokerage company that the account was setup at originally will help you re-title the assets to correctly transfer the inherited IRA to your control. However, you should also look at the investments in the account to determine if they are still suitable to meet your long-term retirement goals.
I would first start out by reviewing the positions or working with an adviser that can give you good feedback on any of the stocks, bonds, commodities, mutual funds, or ETFs that may be in the IRA. You want to look at the track record and fees for all of these holdings as well as the overall asset allocation. You can make investment changes to this account just like you would with any IRA that won't incur any tax penalties for selling positions and purchasing new ones.
I would immediately sell the positions that are dragging down the accounts' performance, hold on to the good investments, and look to re-deploy the cash you have on hand to meet your investment goals. If you are not comfortable making these changes, I would consider working with a fee-only investment adviser that has an investment philosophy that aligns with yours.