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What’s the best thing to do with an inherited IRA?

May 10, 2010 | | Comments Comments Off

Dear Liz: I just inherited about $70,000 in IRAs and checking accounts. I would like to eventually invest it in my next home (upgrade to a bigger home) but want to wait a little until I feel more certain about my job. What is the best thing to do with this money in the interim? Certificates of deposit? Money market?

Answer: If you expect to use the money within a few years, you’ll want to keep it safe and accessible. These days, that usually means in an FDIC-insured savings account, since yields on money market funds are pretty miserable.

You’ll typically find the best rates at online banks or your local credit union. You also can consider boosting your yields a bit by laddering some CDs. That just means breaking your money into chunks and investing those chunks in CDs with different maturities. If you arrange your ladder so that some money comes due every three months or so, you can take advantage of rising rates while protecting the bulk of your cash from falling rates. Just make sure that your money isn’t locked up past the point when you’re likely to need it.

But you may want to reconsider your goal for this money. Unless the retirement money you inherited was in a Roth IRA, you will pay income taxes on your withdrawals. You may be better off in the long run by delaying those taxes as much as possible.

That would require putting the IRA money into a new account, called an Inherited IRA, that you open for this purpose. You would be required to take minimum distributions each year, but those would be based on your life expectancy. The bulk of your inheritance would be left alone to grow tax-deferred for many, many years.

Another option, if the original account owner died before age 70 1/2, is to use the five-year rule. That basically means you could leave the money in the Inherited IRA for up to five years. You could withdraw any amount at any time and pay taxes on it, but you must withdraw everything within five years. That would give you the benefit of at least some tax deferral.

Either way, you would need to establish the Inherited IRA by Dec. 31 of the year after the original IRA owner’s death.

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Categories : Q&A, Retirement