26 May Taxation and investing of inherited IRA distributions

 Q. I have to take Required Minimum Distributions from an inherited IRA, but I don’t need the money and I’d rather save it. What are my savings options, and are there any choices that will help me save on taxes from the RMD?

A. You won’t be able to avoid taxes on your RMDs, but you have plenty of savings options and lots of strategies to lower your overall tax bill.

First, make sure you understand IRA rules.

The IRS generally requires owners of IRAs to begin taking RMDs annually once the owner reaches age 70 ½. The first RMD must be taken by April 1 of the year following the year in which the IRA owner turned 70 ½, said Altair Gobo, a certified financial planner with U.S. Financial Services in Fairfield.

There are special rules for when a beneficiary inherits that IRA.

If the beneficiary is a spouse, they would be eligible to rollover the decedent’s IRA into a “spousal IRA,” Gobo said.

“Non‐spouse IRA beneficiaries are also required to take RMDs from their inherited IRAs,” Gobo said. “How you take them depends on whether the owner died on, before or after their required beginning date (RBD).”

He said if the account owner died before taking distributions, you can choose between the life expectancy method or the five-year method. If he/she died on or after their RBD, you would continue to take distributions based on their life expectancy.

“The life expectancy method requires you to withdraw certain minimum amounts annually according to calculations set forth for the IRA,” Gobo said. “Non‐spouse beneficiaries use the Single Life expectancy tool.”

The five-year method requires that you take all of the distribution no later than the end of the fifth year following the year of the current owner’s death, and there are minimum withdrawal requirements.

“You can withdraw assets at any time as long as you deplete the entire account by the end of the fifth year,” Gobo said. “This option is only available if the IRA owner died before the required beginning date.”

However you choose to take distributions, it will create a taxable event, which are calculated at ordinary income tax rates.

One way to help save on taxes is to increase your gifts to charity, said Eric Furey, a certified financial planner with RegentAtlantic Capital in Chatham.

“This only helps if you’ll be itemizing your deductions instead of taking a standard deduction,” Furey said. “Increasing your charitable gift allows you to reduce the amount of your taxable income, thus reducing your taxes paid.”

He said you should be aware of a common myth: some people believe they can gift the Required Minimum Distribution from their inherited IRA to a charity.

“That’s not the case,” he said. “In the past, the IRS has allowed individuals over age 70 ½ with a traditional IRA to gift their Required Minimum Distribution to a qualified charity up to $100,000, but this does not apply to inherited IRAs.”

Once you have your distributions and you’ve paid the tax bill, you have just about any option for a savings plan — just note these will not help you save on the taxes due on the RMDs.

One option is to simply put the net required distribution (gross distribution less any tax withholding you choose) in a brokerage account, Furey said. Once the net distribution is in a brokerage account, you are free to invest the funds however you choose.

“However, there is a distinct difference between an inherited IRA and a brokerage account,” he said. “The assets in your inherited IRA will grow tax-deferred so any interest, dividends, or capital gains from the assets won’t be taxed until you withdraw the funds. With a brokerage account, you will need to pay tax on any income you receive or capital gains you incur in the year in which the event occurs.”

Take the time to speak to a tax advisor before you make any final decisions.

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This story was first posted in June 2015.