What happens when an adult child inherits an IRA from a parent?

By Robert E. Whitney, Jr., MBA, CFP® Vice President and Senior Financial Planner - The Commerce Trust Company

September 13, 2016

Sometimes, even the simplest, seemingly most straightforward financial transaction can be fumbled in a hurry without having the right expertise at your disposal.

One of the easiest financial transactions to mishandle is an inherited Individual Retirement Account (IRA).

Inherited IRAs involve the transfer of wealth from parents to spouses, siblings, charities, endowments, etc. For illustrative purposes, we are going to concentrate on one of the most common types of transfer, which is from a parent to an adult child.

If you are inheriting an IRA from a parent who has recently passed away, consider these rules in your approach to processing the required documentation:

Rule No. 1 – Do not do anything abruptly. Be deliberate in every step.

  • Do not sign anything, do not cash anything, and do not transfer anything until you have talked to a qualified advisor or knowledgeable family member or friend. Advisors report that inherited IRA recipients too often cash in their IRA prematurely, losing tax benefits that could have been theirs if they had only waited a little longer to reflect carefully. The tax benefits disappear forever once you distribute cash from an inherited IRA, with the distribution amount being characterized as taxable income.

Rule No. 2 – If your parent was past age 70½, find out if he or she made the required minimum distribution (RMD) that year.

  • If yes, great. You won’t have to make one for them.
  • If no, consult an advisor and withdraw the remaining RMD by Dec. 31 of the year of your parent’s passing.

Rule No. 3 – Time your distribution of the proceeds to your particular needs so you can capture maximum tax benefits and avoid penalties.

  • If it is your first time undergoing this experience, it is terribly difficult to know all the intricacies of this important decision. Ask your advisor the best way to capture the full tax benefits and avoid penalties – the answer is largely determined by when you need the proceeds.
  • One commonly used option is to stretch out your tax liability on your RMDs over your entire lifetime to minimize distributions, taxable income and therefore taxes.

An example of stretching out your tax liability over a lifetime might look like this: Assume you inherited your parent’s IRA after he or she passed away in 2016 and had already satisfied the RMD for that year. In 2017, you will turn 50 years old. Based upon IRS Publication 590-B, Appendix B (“Life Expectancy Tables”), you have a life expectancy factor of 34.2. To arrive at your RMD, you would divide the balance at the end of the prior year by the life expectancy factor. For example, assuming the inherited IRA was valued at $100,000 as of 1/1/2017, your RMD would be $2,924.

Now this is the part of the process where most financial fumbles occur. If you fail to take your RMD, you will be subject to a 50% IRS penalty on the amount you failed to withdraw. Sounds harsh, but it is the law. While you can distribute more than your RMD, be aware you lose out on the tax-deferred benefit in addition to recognizing additional taxable income.

Be sure to document your life expectancy factor in the first year, because the factor is reduced by one for subsequent years when calculating inherited IRA RMDs. Therefore, in 2018 you would use a life expectancy factor of 33.2.

An advisor can help you avoid the pitfalls so you don’t accidentally wreck your tax advantages by acting impulsively or without being fully informed. There are also ways to pass the inherited IRA to grandchildren, too, which effectively extends the tax breaks for decades.

If you are a parent reading this commentary, you may want to huddle with your children and get your beneficiaries updated, especially if the IRA has high value. If you are an adult child, do not be misinformed and subject yourself to IRS penalties or waste an opportunity to capture tax-deferred growth with the inherited IRA.

Disclosures
  • Past performance is no guarantee of future results, and the opinions and other information in the commentary are as of Sept. 13, 2016. This summary is intended to provide general information only and is reflective of the opinions of The Commerce Trust Company’s Financial Advisory Services Group.
  • This material is not a recommendation of any particular security, is not based on any particular financial situation or needs, and is not intended to replace the advice of a qualified attorney, tax advisor or investment professional. Diversification does not guarantee a profit or protect against all risk.
  • Commerce does not provide tax advice or legal advice to customers. Consult a tax specialist regarding tax implications related to any product and specific financial situations.
  • Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
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Considerations before Buying a Second Home | The Commerce Trust Company

Considerations Before Buying a Second Home

By Ryan Fleming Relationship Manager - The Commerce Trust Company

May 24, 2017

Background

It is estimated that between 6 and 10 percent of homes in the United States are second homes. If you are considering buying a second home, now could be a good time to take the leap with interest rates still near historic lows. Ryan Fleming, a Commerce Trust Private Banking Relationship Manager in Bloomington, Ill., discusses some common considerations for second-home buyers.

Q. Ryan, what are some of the pros and cons of a second home?

A second home purchase can fulfill a lifelong dream or become a nightmare. Many buyers can avoid the nightmare scenarios by making a balanced and informed decision.

The downside of buying a vacation home is that you will have two of everything – mortgages, property tax bills, water bills, fuel bills, etc. It also means additional responsibility for repairs and general upkeep.

At the same time, owning a second home can be very rewarding in tangible and intangible ways. It can be the source of relaxation, a place to get closer to your family or to engage in your passions or hobbies. It can also generate income if you choose to make it an investment property.

Q. What should a potential second-home buyer consider before making a purchase?

Think about your goals for the property. Do you want to buy a vacation home that will one day become the place you retire to, and perhaps even pass on to your children? A second home for vacations is very different from an investment property that you buy to generate income. That difference can affect your taxes and the insurance coverage you will need.

Many second-home buyers rent out the property part of the year to offset their expenses. There are different tax rules depending on how much you use the property for personal or rental use. There are many more considerations that are best explored with your accountant or financial advisor.

Q. Good tip. What else?

Take a look at the numbers. Consider whether you can afford to take on a second mortgage, plus insurance, maintenance, repairs, furnishings, and property-management fees, if you choose. Prices can vary greatly by region. Developing communities are less expensive than established vacation hot spots. An experienced real estate professional can help.

Q. What about getting a mortgage on a second home?

An experienced banker can be invaluable in helping to understand the costs of purchasing a second home and the loan options available to you. They can look at your current financial situation and the property you want to purchase, and advise you on what type of loan you may be eligible for. A banker can also help you get prequalified or preapproved for a loan before you start looking at properties, so you know what you can afford to buy.

Q. Any final thoughts?

Before searching for a second home, it is important to clearly define your goals for the home – whether it is a retirement destination, an investment property, or used for other purposes. Next, build your team of professionals, including a banker, tax advisor, and real estate agent who can help you navigate the process. Remember that purchasing a second home is a big decision that should be made carefully, and in the context of your total financial life. So be sure to include your financial advisor or planner.

Takeaways:

  • Think about your goals for the property. A second home for vacations is very different from an investment property that you buy to generate income.
  • Consider whether you can afford to take on a second mortgage, plus insurance, maintenance, repairs, furnishings, and property-management fees.
  • An experienced banker can be invaluable to understand the costs of purchasing a second home and the loan options available to you.

About the author - Ryan Fleming

Ryan Fleming

Ryan is a private banking relationship manager for The Commerce Trust Company. As a member of the private client team and an experienced, tenured private banker, he and his dedicated client support staff are responsible for ensuring each client's experience with Commerce Trust exceeds expectations. Ryan's specific responsibilities include management of our clients' day-to-day banking, cash management, and credit needs, while also helping them navigate the wide array of our financial services to find the solutions that best fit their needs. Prior to joining Commerce Trust in 2013, Ryan was a branch manager for Commerce Bank in Champaign. Ryan has a bachelor of science degree in agribusiness, farm, and financial management from the University of Illinois.

Disclosures
  • Past performance is no guarantee of future results, and the opinions and other information in the commentary are as of May 24, 2017. This summary is intended to provide general information only and is reflective of the opinions of The Commerce Trust Company.
  • This material is not a recommendation of any particular security, is not based on any particular financial situation or need, and is not intended to replace the advice of a qualified attorney, tax advisor or investment professional. Diversification does not guarantee a profit or protect against all risk.
  • Commerce does not provide tax advice or legal advice to customers. Consult a tax specialist regarding tax implications related to any product and specific financial situation.
  • Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
Connect with Commerce Trust
Contact us to learn more about how our approach might fit with your financial situation.
Learn more

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