Splitting An Inherited IRA To Maximize Tax Savings

If you are the beneficiary of an inherited IRA that has multiple beneficiaries, December 31 can be an important due date in order to save taxes.

Many owners of IRA accounts will name multiple beneficiaries. When the IRA owner dies, any non-spouse beneficiaries must take required minimum distributions (RMDs) from the inherited IRA over the shortest life expectancy of any of the beneficiaries. For example, if two daughters are the beneficiaries, the RMDs will be calculated based on the older daughter’s age.

To provide flexibility for each beneficiary and to potentially save significant taxes, you should consider splitting an inherited IRA into individual IRA accounts for each beneficiary. This way, a younger beneficiary will not be penalized by having the RMD calculated based on the oldest beneficiary. The results can be magnified if there are large age differences among the beneficiaries. If the inherited IRA is split into two inherited IRA accounts for each of the beneficiaries, the younger beneficiary can use his or her own life expectancy to calculate the required distributions. This will result in lower distributions, lower income taxes, and allow the IRA balance to grow more over time.

Splitting the IRA must occur by December 31st of the year following the year of death of the account holder. For example, if John had an IRA and he died in 2016, the account would have to be split up into individual IRAs by December 31, 2017.

Not only does splitting an inherited IRA save taxes for younger beneficiaries, it allows a great deal of flexibility for each beneficiary in terms of investment styles. This strategy allows each beneficiary to choose investments according to their own needs, independent of what the other beneficiaries are doing. For example, one beneficiary may want to invest in a very aggressive stock portfolio, while the other may want to invest extremely conservatively. If the inherited IRA was not split, all beneficiaries would have to agree on an investment style for the entire portfolio.

Lastly, splitting the inherited IRA into separate accounts allows one beneficiary to take the RMDs while the other could take a much larger amount of his portion of the IRA. This would not be possible if the IRA was not split.

But remember, if you are a beneficiary of an IRA from a decedent who died in 2016, you have until December 31, 2017 to split the IRA.