If you recently inherited an IRA (individual retirement account), the first thing to know is that they do not operate like Canadian RRSPs or RRIFs. The second thing to know is that most non-spouse beneficiaries must withdraw the entire account within 10 years, and the choices you make in the first weeks can affect how much of the money you actually keep. The inherited IRA rules changed significantly in recent years, and the old advice about stretching withdrawals over your lifetime no longer applies to most people.
What is the 10-year rule?
For most adult children and other non-spouse beneficiaries, the account must be emptied by the end of the tenth year after the original owner’s death. Depending on when the original owner passed away and whether they had already started required withdrawals, you may also need to take withdrawals along the way rather than waiting until year ten. The rules have shifted more than once, so it is worth confirming your specific timeline rather than relying on something you read a few years ago.
Do spouses have different options?
Yes, and they are sometimes better ones. A surviving spouse may be able to treat the inherited account as their own, which may allow withdrawals to be spread over their lifetime. Certain other beneficiaries, such as those with a disability or chronic illness, may also qualify for more flexible treatment. If you think you might fall into one of these categories, it is worth confirming before making any withdrawals.
Why does the timing of withdrawals matter?
Because most withdrawals from a traditional IRA count as taxable income to you. Emptying the account in a single year could push you into a higher tax bracket, while spreading withdrawals across the 10 years often produces a smaller total tax bill. The best schedule depends on your income, your plans, and the size of the account, which is why a little planning up front can be worth a great deal.
What mistakes should you avoid?
A few come up again and again: Cashing out immediately without understanding the tax hit – in all applicable jurisdictions. Retitling the account incorrectly, since an inherited IRA must be moved in a specific way to preserve its status. Missing a required withdrawal, which can bring penalties. And forgetting to name your own beneficiaries on the inherited account.
These mistakes can be avoided once you know the rules, but may be difficult to undo after the fact.
What should you do first?
Take a breath. Very little about an inherited IRA has to happen overnight, and rushed decisions cause most of the problems. Gather the account information, confirm how the account will be titled, and talk with professionals who understand both the US and Canadian tax rules. You should also talk to financial professionals who are licensed and experienced to deal with US accounts such as the IRA.
Finally, you need to consider how the account fits into your broader picture as a resident of Canada, who may be a U.S. citizen, dual citizen or simply a Canadian citizen resident in Canada.
In summary
An inherited IRA comes with deadlines and tax choices that deserve a thoughtful look before you touch the money. In conjunction with our independent US-qualified professional contacts, we can help you understand your options and coordinate with your next steps.
Contact us at info@botsfordlawtep.com to arrange an initial consultation to discuss your estate law needs.
The above commentary is based on the laws of Ontario and those of Canada applicable therein. This blog post is not intended as legal or other professional advice. Please consult appropriate advisors before taking any action.
Plan well. Live well. Leave an organized estate.