Can you cash out an inherited IRA? This is a question that many individuals face when they inherit an IRA from a loved one. While the answer may seem straightforward, there are several factors to consider before making this decision. In this article, we will explore the rules and regulations surrounding cashing out an inherited IRA, as well as the potential consequences of doing so.
Inheriting an IRA can be a complex process, especially when it comes to understanding the tax implications and financial planning involved. An IRA, or Individual Retirement Account, is a tax-advantaged savings account designed to help individuals save for retirement. When someone passes away, their IRA becomes an inherited IRA, and the rules governing it can differ significantly from the original account holder’s.
One of the primary considerations when deciding whether to cash out an inherited IRA is the tax consequences. Generally, the entire balance of an inherited IRA must be distributed within a specific time frame, which is determined by the relationship between the original account holder and the heir. For example, if the heir is the surviving spouse, they can roll the inherited IRA into their own IRA and continue the tax-deferred growth. However, if the heir is not the surviving spouse, the distribution rules are more stringent.
For non-spouse beneficiaries, the inherited IRA must be distributed either within five years of the original account holder’s death or by the end of the 10th year following the year of death, whichever comes first. This means that if you were to cash out the entire balance of the inherited IRA, you would be subject to income taxes on the entire amount received in the year of distribution. This could potentially result in a significant tax burden, depending on the size of the IRA and your income level.
There are, however, some exceptions to the five-year or 10-year rule. If the inherited IRA is a Roth IRA, the distribution rules are different. With a Roth IRA, the earnings are tax-free, and the account holder can withdraw their contributions at any time without any tax implications. Non-spouse beneficiaries of a Roth IRA can take advantage of this feature by taking out the contributions tax-free, while the earnings are subject to income taxes over the 10-year distribution period.
Another exception to the distribution rules is if the heir is a minor. In this case, the inherited IRA can be stretched over the minor’s life expectancy, which allows for more tax-deferred growth. However, this option is only available until the minor reaches the age of majority, at which point the remaining balance must be distributed according to the standard rules.
Before deciding to cash out an inherited IRA, it is crucial to weigh the tax implications against the potential benefits of keeping the account intact. In some cases, it may be more advantageous to leave the inherited IRA untouched and continue the tax-deferred growth. This can be particularly beneficial if you are in a lower tax bracket than the original account holder or if you expect to be in a lower tax bracket in the future.
In conclusion, while you can cash out an inherited IRA, it is essential to understand the tax implications and consider the potential benefits of keeping the account intact. Consulting with a financial advisor or tax professional can help you make an informed decision based on your individual circumstances. By carefully considering your options, you can ensure that you make the best choice for your financial future.
