Inherited IRAs could be mistaken for traditional IRAs in divorce. The consequence can be dramatic and costly.
An Inherited IRA could inadvertently be treated as a traditional IRA, included as a community asset and divided in the decree – mistakes that could cost the beneficiary of the Inherited IRA thousands in both the amount included in the community estate and unexpected taxes. Even when the Inherited IRA is recognized as separate property, a couple may be contemplating its transfer to equalize an estate without knowledge of the tax implications or the consequences of transfer.
An Inherited IRA is an IRA that was established for someone who is now decreased. The Inherited IRA typically “benefits” a living beneficiary although it could also benefit a trust or charity. Like a traditional IRA, an Inherited IRA grows tax free until proceeds are withdrawn. Taxes are paid at ordinary rates upon withdrawal. Unlike traditional IRAs, the beneficiary of an inherited IRA can withdraw at any time without penalty. Traditional IRAs incur a 10% penalty for withdrawals before the age of 59 ½.
The beneficiary of an Inherited IRA is not treated the same as the owner of a traditional IRA with respect to rollovers and other benefits. Unlike traditional IRAs, the beneficiary may not rollover the Inherited IRA to his/her own traditional IRA, his/her spouse’s IRA incident to divorce or a new IRA set up for his/her spouse incident to divorce without first withdrawing the funds, which will incur taxes at the beneficiary’s ordinary rates. Also unlike traditional IRAs, withdrawals cannot be taken and then put back into an Inherited IRA within 60 days to avoid taxes on the withdrawal. For traditional IRAs, this type of withdrawal and reimbursement is permitted once a year.
One of the main reasons rollovers are not available for an Inherited IRA is the Required Minimum Distribution (“RMD”) rule, which complicates transfers.
These rules can complicate transfers of traditional IRAs as well. Required minimum distributions for traditional IRAs start at age 70 ½ if the owner is still living. If a divorcing spouse is already talking required minimum distributions, further analysis and negotiation is needed to divide or transfer the account.
In divorce, there may be more questions or other options that are unique to each situation. IRA, tax and ERISA rules can change. Divorcing clients and their attorneys should seek advice from a qualified CPA or financial advisor.
Investment advisory services offered through Robertson Stephens Wealth Management, LLC (“Robertson Stephens”), an SEC-registered investment advisor. This material is for general informational purposes only and is not tailored to the needs of any specific individual. Any discussion of U.S. tax matters should not be construed as tax-related advice. Please consult your personal tax advisor for more information. © 2020 Robertson Stephens Wealth Management, LLC. All rights reserved. Robertson Stephens is a registered trademark of Robertson Stephens Wealth Management, LLC in the United States and elsewhere.