Inherited IRAs – Please Avoid this Mistake

by Neal Frankle, CFP ®

Inherited IRAs are nice. They’re found money…right? Someone else worked hard and built up their IRAs so you could inherit them. Sweet.

What’s not to love?

But there are big problems too. It’s so easy to make mistakes. A few weeks ago I received a question that illustrates the issue from Z, a loyal Pilgrim.

The first e-mail I received asked which are the best investments for inherited IRAs. He was considering putting the money into an annuity. While I generally dislike annuities, I needed more information before I could respond.

I assumed that Z was concerned about investing his money safely, and of course I respected that. But I learned that this wasn’t Z’s money at all.

Turns out it was his daughter Jenny’s money. She had inherited IRAs from her grandmother. Jenny is 29 years old. She turned to her father for advice and Z was concerned about the market. That’s why he sent me the question.

Z has every right to be concerned about his daughter – and the market. He wants to make sure Jenny makes intelligent investments. But Z is a different person from his daughter. She is 29 and has a much longer investment horizon than Z.

While Z’s daughter will be forced to take a small distribution out of the account, she can stretch that money for decades and decades. Assuming she’s not in debt or has no other immediate need for the money, the smartest thing for her to do would be to take the smallest distribution possible from those inherited IRAs and allow the money to work as long as possible. She should be focused on creating wealth with that money.

How should inherited IRAs be invested?

In Z and Jenny’s case, a portfolio made up with at least 60% equity would likely be smart. Of course there will be years where Z and his daughter will be sorry they ever heard of Wealth Pilgrim because the market will be terrible. But if they both remember that she is investing for many decades, there is no question that a portfolio made up largely of equities makes the most sense.

Again, this is not about providing the most comfort over each and every quarter or year over the next 50 years. This is about maximizing the income and growth of these inherited IRAs over the next several decades. The price of this decision will be discomfort in the short term and unfortunately, nobody knows how severe that discomfort will be or the timing of it.

But as uncomfortable as it may be to sail through those rough storms, Jenny should invest that money for growth.

Would your advice be any different for someone with an Inherited IRA?

 

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{ 7 comments… read them below or add one }

Evolution Of Wealth March 29, 2010 at 7:45 AM

I think Evan brings up the best point. The goal for Z should be to get his daughter involved and learning now. The more he gets her involved in the discussion the more and quicker she can learn how to manage her own finances. An inherited IRA can be a big responsibility.

PS- thank you for the mention.

Reply

Evan March 28, 2010 at 6:44 AM

I think I would be worried about how involved Dad is in the inherited IRA. Jenny needs to be asking these questions, or she’ll be just invading the corpus, paying her income tax and moving on before she is 33

Thanks for the link!

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Derek March 27, 2010 at 9:36 PM

Good advice, definitely keep it in the market if she is 29. She’ll thank you in 30 years. I’d probably have more than 60% myself, but I guess some people need a little less risk and I can understand that. 60 is a good step from an annuity.

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Brad Chaffee March 26, 2010 at 3:38 PM

Thanks for the link love! :)

I agree completely about Punch Debt in the Face. Hilarious and the pics alone are worth it.

Reply

JoeTaxpayer March 26, 2010 at 9:50 AM

In my brokerage accounts, I am allowed to reinvest dividends, getting fractional shares and no commission. At her age, with such a low RMD, I’d suggest an index ETF that’s easy to understand, the SPY (S&P 500) or even DVY (the higher dividend Dow stocks) for the bulk of the money. 60% will capture most of the gain at lower standard deviation, if that’s their comfort level.

I manage funds for an 80 yr old, still at 50/50. Enough cash to cover till the IRS says she’ll pass, and enough stock for growth for her daughters.

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Paul @ FiscalGeek March 26, 2010 at 9:46 AM

Excellent advice Neal, this scenario would be a great wealth building option rather than a one time splurge. That being said I guarantee if I had received that IRA when I was 29 it would have been gone. Here’s to second chances!

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Money Funk March 26, 2010 at 7:24 AM

I agree that Jenny, being younger, should invest the inherited IRA. I still hear that even when the markets have been week, at times, a long term investment is well worth it.

BTW, thanks for the Link Luv. And nice Guest Post at Financial Samurai’s!

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