Some time back, I wrote a post called “On My Death, Please Take a Breath” about how one should wait before doing anything in haste financially after the passing of a loved one. I paid specific attention to the inheriting of an IRA, and received some feedback prompting a longer discussion.
First, there are different rules if you inherited the IRA from a spouse or non-spouse. If your spouse passed and left you an IRA, you are able to roll it into your own account, and treat it as your own.
If you inherited the IRA from a parent (for example) or other non-spouse, the rules are a bit tricky, but not impossible, to understand. The IRA becomes retitled as JoeTaxpayer, beneficiary, Charles Schwab Custodian. It’s most important to note, the funds can NOT be mingled with any other funds you have. You must begin taking withdrawals by December 31 of the year following the person’s death, and you use the life expectancy table 1 in Appendix C of IRS Publication 590 to determine your required distributions. Note also, you refer to this table once only, for the initial distribution. In subsequent years, you reduce the divisor by 1, unlike withdrawals from your own IRA after 70-1/2 where you refer to the table each year to find your new withdrawal requirement.
Another important point – If the original IRA had contingent beneficiaries, you may disclaim your inheritance and allow the next in line to inherit the IRA. Why would you do this? If you are a high earner, in a high tax bracket, you may not need the money at all, or if the next person listed as beneficiary is your child, their RMDs (required minimum distributions) may be so small, they avoid tax, or are minimally taxed.
While on the topic of contingent beneficiaries, an IRA must have its beneficiaries noted on the account, they are not inherited through a will. If there is no beneficiary listed on the account or if the only beneficiary either pre-deceases or dies along with the account owner, the IRA funds must be withdrawn by the heirs within five years of the passing of the owner. Note, in your will you can include instructions to your beneficiaries not to withdraw the funds (i.e. not to ‘cash out’ the account 100%, but only take RMDs, this is a note you’d include, it’s not binding) in the IRA after your passing. This is the worst decision they can make. If they are afraid of the stock market, or don’t understand the investments you left them, they should simply change its contents to Treasury bonds or CDs.
Lastly, this is a complicated topic, it’s easy for even the so-called pros to make an error. Read up to understand the rules, and ask questions before you make a tragic mistake and are hit with a huge tax bill. A final note, I mention nothing about converting your inherited IRA to a Roth IRA. This is not allowed for a non-spouse beneficiary, and for a spouse, only if they put the IRA into their own name first.
Help! I’m so confused… My Father passed in Aug. 2011 and his Roth IRA was transferred to my Mother’s account. My Mother passed away in Feb. 2012 and my brother and I received a check for 1/2 the amount (@ $25,710). I put my portion in my Mom’s Estate account and shortly thereafter transferred my portion into an Annuity Fund offered by my bank. I received Form 1099-R as beneficiary with my social security number. My question is, do I have to pay Federal Income taxes even though I moved it into an Annuity?
Let’s take it a step at a time –
When Mom inherited Dad’s Roth, it became her account. No issue there.
When you and your brother inherited, it should have remained as an Inherited IRA, to offer you the chance to keep it growing tax free as you take RMDs. But as you note, it ws withdrawn. Since it was a Roth IRA, no taxes are due from either of you, regardless of the subsequent investment.
Joe,
Thanks for all of the great information you have provided! I have a question that I’m hoping you can shed some light on. My father passed and left his IRA to myself and my brother, each of us inheriting a 50% share of the account. My brother is proposing to sign over his share to my name, and then have me cash out his 50% amount because I’m in a much lower income income tax bracket and live in Florida with no state income tax. Then he suggests that I write him a check for the amount I receive, after proper taxes are withheld according to MY residency and tax bracket. My question is, is this even legal? What are the implications of doing this? He says his tax attorney says it’s completely legal, but something doesn’t seem right about it to me, I somehow feel like this is backdoor way at tax evasion. Thanks for your help!
A note to my readers – this question was featured as a full article at my companion site RothMania today in an article titled The Step Transaction Doctrine. At RothMania I focus on the Roth IRA, the Roth 401(k), as well as other retirement account issues.
This has been an amazing read following through all of your queries and comments. I am in Maryland where many people put together a by-pass trust so that the $1M exemption from State Estate Taxes is not lost when the first spouse dies. Since 90% of our non-house assets are in two IRA’s (one for my wife and one for me in approximately equal amounts), the only way that such a trust accomplishes the desired result is to make each of spouse’s Trusts the beneficiary of the IRA’s. What I have slowly begun to realize is that if we simply designated our two kids the beneficiaries of the IRA’s it would accomplish much the same goal without going through the hassle of establishing a trust. In the event of both parents passing the kids get all the IRA’s anyway. We have retirement annuities that cover daily expenses so that these investments are really only used for paying out supplementary income. Does it make sense to you that we keep things simple by just using the beneficiary part of the IRA to pass along the bulk of our assets to the kids?
As long as you wont need access to your wife’s IRA (or vice versa) if she passes first, your plan sounds fine.
Trusts are great for certain purposes, but as you discovered, the beneficiary designation on retirement accounts is adequate for most people. Remember, Insurance is considered part of your estate if you own it (i.e. regardless of beneficiary, if you control the insurance, you are the owner).
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Hi, my dad past away back in March and left an IRA account to be split between me and my 3 sisters. We all took the lump sum. I would like to put the money into an IRA under my name. WIll this save me in paying taxes on this money and how long do I have to make this decision/
Thank you
If you took a withdrawal of your share, you can’t put it back into an IRA, that option no longer exists. The proper way to do this was to maintain the IRA as an inherited IRA and start to take required minimum distributions next year. If this was all pretax money, you owe tax on the full amount.
The best I can suggest is that you increase your deposits to your 401(k) or IRA and use this money to help offset those deposits.
To be clear, inherited IRAs have no 60 day rollover option.
I’m sorry for your loss.
My father died in late November of 2012. We are now finishing his tax return. He had several IRAs that were transferred to us children as beneficiary IRAs in January 2013. He had not taken all of his RMDs for 2012. One of the IRA institutions withdrew(in 2013) what their RMD was from his account before transferring the balance to us heirs. They sent each of us a check in 2013. It is noted as an a RMD for 2012. The total actually is much more than he needed to take as he had already withdrawn most of what he was required to take out of his IRAs for 2012 from other accounts. I know that a waiver of the 50% penalty needs to be asked for. When doing his tax return for 2012 do we tell IRS that the required minimum distributions were not taken and then ask for a waiver of the 50% penalty on his return or is that something that needs to be done when we file our own returns for 2013? Basically, who needs to ask for the waiver of penalty? Him, or the heirs?
You said “It is noted as an a RMD for 2012.” If that’s the case and the 1099 reflects that, the RMD for 2012 is satisfied.
It is noted as 2012 RMD but it came in our social security numbers, not my dad’s and the RMD was received in 2013. I think I didn’t make it clear that I was referring to the RMDs that my dad had to take in 2012 which would have been based on the account balances as of Dec 31, 2011. Sorry about that.
I believe I understand the details. I am reading from Ed Slott’s “The retirement Savings Time Bomb” p128:
“If an IRA owner names an individual (a son or daughter, for example) who is not the spouse as beneficiary, it will generally not matter whether the owner dies before or after the RBD because non-spouse designated beneficiaries get to use their own life expectancy is to calculate post death RMDs on inherited IRAs, the first of which must be taken by the end of the year after the year of the IRA owner’s death.”
This reads to me that the deceased is never penalized the 50% for a missed RMD, and that you now take RMDs as beneficiaries based on your own ages and the 2012 year end value of your share.
Thank you for your easy-to-follow explanations. I’ve just finished reading every entry and am hoping you can help me out. My situation is similar to that of entry 29. My mom passed away 6/2007 at age 67. She had two traditional IRA accounts, and my two brothers and I were named the beneficiaries. Unfortunately, my brother did not do anything with the account, and now that I am researching, I believe that we should have taken RMDs within the first year of her passing in order to have the stretch option. We have never taken any RMDs. Although Dec. 31, 2012 would have technically marked the 5 year point, I found one article that said that because 2009 was such a tough financial year for people, RMDs were not required for 2009. In turn, the year 2009 does not count toward the 5 year rule. Is this correct? Is our only option to take all the money out (about $220K) and suffer the tax consequences? Is there any recourse? I have heard there is a 5329 waiver form and that sometimes a letter to the IRS can help. I’m confused about what our options are at this point and would so appreciate any advice.
Hi Gretchen, I’m sorry for your loss. You are right about the choices. IRA rules are so complex, a sympathetic agent getting the 5329 waiver may accept the excuse, and let you take the 4 years of missed withdrawals. I’m unaware of any delay to the 5 year rule even though there was the year with no RMD.
Before doing this, I’d do the math. If you were 40 when Mom passed, your first year RMD was 1/43.6 or 2.3% of the balance. When you add the 5 missed years, the total might add to just 15% or so. So a 50% penalty is half of the missed withdrawals or just a 7.5% total hit, less than the extra tax of each taking $110K all at once and getting thrown into a higher bracket. See publication 590, and form 5329, and let me know if you have a follow on question. Good luck to you!
Update – indeed, the 2009 waiver extends the 5 years to 6, per http://www.irs.gov/pub/irs-drop/n-09-09.pdf and the sentence “If a beneficiary is receiving distributions over a 5-year period, he or she can now waive the distribution for 2009, effectively taking distributions over a 6-year rather than a 5-year period.” So, it appears you can choose between a tax hit now or try to get forgiveness on the missed RMDs. If you don’t get the forgiveness, you can still choose between emptying the account and paying the tax or keeping them going, but pay the 50% penalty.
Hi, My father-n-law passed away Jan 2011. His 401K account was split equally among 3 children, one being my husband. 1 child kept the $ as a qualified account and did not take any withdrawals. We took our portion as a lump sum withdrawal and had taxes withheld. The grand total was $96K and we rec’d $72K after taxes. We just this past weekend received a tax bill for $10K. The IRS is stating we had $96K of unreported income, but we had them withhold taxes before sending us the $. Thoughts? How can I determine enough was withheld initially?
I inherited an IRA from a parent a few years ago and have been making the minimum required withdrawal since then. Should I decide I now would like to gift this IRA to my 3 children (divide it equitably), can this be done?
David – If they were contingent beneficiaries, you could have disclaimed your share and let it flow to them. It’s too late now.
The best you can do it to take the RMD, pay the tax, and gift them the proceeds, up to $14K/yr per child (or $28K/yr if you joint gift with your wife to the kids.)
If your children are old enough to work, this money can be used to fund their own Roth IRA, up to their income or $5500, whichever is lower.
Be sure to update the beneficiaries on the IRA now, it’s easy to forget to do this. I’m sorry for your loss, and wish you well.
Jessica – It sounds to me like you made a small mistake. Did you include the $96K on your tax return, and also mention the $24K that was withheld? From what you’ve told me, it looks like this was an oversight, and you still have the chance to amend your return. Instead of a tax bill, you may be in line for a refund, as they say you we $10K, but had $24K withheld for taxes.
Note – whether or not enough was withheld initially, it’s that year’s return where the reporting and reconciling occur. Let me know how it goes. Thanks for writing in!
Hi Joe – great site! My Mother passed away recently and left a traditional IRA to myself, my minor daughter and a small portion to her sister. The portion for my daughter is $48k. We are in NYS. The company managing the IRA said they cannot transfer the portion designated to my daughter as she is a minor – what are our options? As a side note, the named executor of the estate (the sister), has been awful to my daughter and I excluding us whenever possible. The lawyers that wrote the will said that there is nothing in the will regarding setting up a trust for my daugher.
I happen to use Schwab, but this would work for Fidelity, Scottrade, etc.
Go to a Schwab office or get an agent on the phone. Ask for a direct transfer of the account to the new broker. It will be titled as Mother’s Name, Deceased, for benefit of Granddaughter’s Name, and you will be the custodial on the account. Your daughter will have an RMD each year, which will be taxable, but small enough that it should not trigger Kiddie Tax rules. Having a minor inherit an IRA should not be an issue. You should not keep the funds with the current company. They are on track to give your daughter an unneeded tax bill. No trust is needed. An IRA with beneficiary designation passes outside of any will.
This site has a lot of useful information on IRAs. Thank you. My ex husband named me a beneficiary on his rollover IRA. He passed away recently. I am trying to find out what rules apply in this case. Do the rules for non spousal beneficiaries apply? For instance taking distributions depending on my life expectancy? Or can it wait till he would have turned 70 and a half?
Exactly right, you are a non-spouse beneficiary and will need to start taking withdrawals based on your life expectancy. See publication 590 for the table you’ll f
Refer to for your first withdrawal.
Thanks for writing in, I am sorry fr your loss.
My grandmother passed away last month. My father spoke with my mother yesterday and insisted she get my SSN and to do whatever it took to get it. I am hesitant on giving my SSN because something doesn’t feel right. He told my mother that him and his sister, my aunt, cashed out the IRA and paid the early withdraw fees & taxes but they need my SSN because there was some that they couldn’t get and they want to list me as the beneficiary. Does this make any sense to you
None of these makes any sense. They cashed out the IRA, but no fees or tax is due until April on their tax returns. As far as giving you anything, your father needs to tell you exactly what he’s transferring to your name. You should be going to the bank or broker in person and he should not need to act as intermediary. If he has no access without your number, it seems to me that you are the beneficiary, and he has a legal obligation to tell you what it is.
I have been really confused about it all day. Then today my aunt text me and asked me if I gave my dad my SSN. I told her no and asked why. Her response was papers and then text again and said legal stuff. I told her I didn’t understand why my SSN was needed since her and my father cashed everything out. She replied with no there is more stuff and then said it is for my benefit. You answered some of my questions with your repsonse which I appreciate very much. So should I just ask them what they are transferring to me? If they need my SSN then I should be able to speak with someone from there and see what is going on right?
Yes, I’d ask to meet with the institution holding the funds.
I am trustee for my Mother In Law’s Estate. If her other daughter wants her inheritance, and not give me her SS#, I just send her into the Schwab office and tell her the account number she’s inheriting. No hiding anything to do my job.
Unfortunately, this happened about 10 years ago, but some things came up and now I have questions. I was the executor of my father’s estate. Everything was split between my brother and myself. My father had an IRA worth $70,000 which the attorney cashed in. In 2003, I received a 1099 in my name and social security # on behalf of my father for the IRS. I had to claim the whole $70K on my 2003 income tax return and pay over $13K in state and federal income tax that year. If it was split between my brother and I, why did the 1099 come in my name only? So, actually my brother made out?
Kelly – thank you for visiting and writing today. I’m sorry for your situation. More so, I’m sorry that so much time has passed. Multiple mistakes were made in the events you describe. The account should have been split into two separate accounts after your dad passed. This would have given each of you the option to take distributions over your lifetime if dad’s IRA had proper beneficiary designations listed. If the IRA passed without such designation, via a the will, you still would have had 5 years to withdraw the money.
More important, splitting the account would have split the income to claim on your taxes. It’s not proper for one beneficiary to pick up the bill for money another beneficiary received. Your brother avoided the tax on his half of the IRA. He might not have realized at the time that IRA withdrawals are potentially taxed to the beneficiary, they are inherited tax free, but are still taxed on withdrawal. The lawyer should have known better.
Fascinating read here.
We’re in limbo right now with inherited IRAs. Mom died in 2011 and her living trust was named the beneficiary of three separate IRA accounts. Her financial advisor worked with trust beneficiaries and the lawyer/trustee so that we could elect the stretch option by setting up properly named inherited IRA accounts.
Unfortunately the trustee filed death benefit claim forms electing lump sum distributions with funds further distributed to financial institutions for the new IRA accounts.
The trust received 1099-R forms for the full amount of the distributions as death benefits. The amounts are not reported on Form 1041; a copy of this return was received last week.
I’m of the opinion that the “fatal error” made by the trustee in liquidating the IRAs will result in them being disallowed by the IRS and thus we should be reporting the distributions as taxable income now. Unfortunately, neither tax accountants or our lawyer have come to that conclusion so that we are still sitting in limbo.
Are the IRAs now titled, “[Name of Mom], Deceased, for benefit of [Name of Daughter]”? Assets can be sold within the IRA without triggering any tax or issue at all. The key thing is that assets be kept as IRAs, an the direct transfer made to the new institution if that changed. It sounds like the trustee may have gotten it right.
Joe, the trustee elected lump sum distributions and received three checks which were deposited into a money market account INO the trust. Seven months later, she had checks sent to financial institutions, payable to the new inherited IRA accounts. Trust received 1099-R forms showing full distributions; these would not have been issued if proper trustee-to-trustee transfers had been done?
I don’t see this as assets being sold within the IRA-my view is the IRAs were liquidated with proceeds deposited into the trust account?
Excellent point. I’d sit with the trustee to make sure all was done correctly. I’d like to understand how the 1099-R was handled by the trustee if the 1041 didn’t show this as income. A transfer does result in a 1099-R. When I transferred a pension buyout, I saw a 1099-R and it was reconciled by claiming the transferred deposit. So the 1099 itself isn’t definitely a sign of an error.
Joe- we have had to hire a lawyer due to difficulties with the trustee, who is non-reponsive to requests for info. She has reported no IRA activity to the IRS, not even 2011 RMDs which were taken while Mom was still alive. She prepared “informational” 1099-Rs for beneficiaries coded rollover, but did not send them to the IRS or the beneficiaries. They are part of the file copy of the tax return. The way I understand it, info reported on 1099R and 5498 will not match up, triggering a notice from the IRS.
Wish we could sit with the trustee, but she is uncooperative. We now deal with her through a lawyer, who will be asking her questions on the return. I wonder how her approach is justified, especially because she did not report one beneficiary’s lump sum distribution.
Thanks for your help, Joe.
Peeps out there, please do your homework before taking any action. We (ten beneficiaries) are looking at having to pay out over $400K in taxes. That is a big OUCH to me. 🙁
Joe,
My daughter has an inherited IRA and is receiving RMD’s. Since she was a minor when receiving the inherited IRA I was listed in the title as Guardian. Now that she is an adult I would like to re-title the inherited IRA without me listed as Guardian. The broker that has the account sent me a new application containing 24 pages for her to complete in order to accomplish this. I want to make sure she will not be “breaking” the inherited IRA and then subject to the 5 year rule. I obviously want to keep the RMD provision intact.
Should I be concerned with how this is being handled?
Thank you.
Joe – Need help with a question regarding renaming an inherited IRA. My mother’s fiancé died and left her as the named beneficiary on his IRA. It was correctly renamed “Bob (deceased) fbo Emily”.
My mom then named me as her beneficiary on her new inherited IRA.
My mom has since died and now I am her named beneficiary. Do I rename this inherited IRA for me as “Bob (deceased) fbo Mike” since he was the original account owner, or should it be renamed “Emily (deceased) fbo Mike”?
Not clear on this since I am the 2nd to inherit and everything I read indicates to retain original account owner’s name when renaming an inherited IRA.
Thanks.
Yes, you are right to be concerned. It’s too easy for retitling to go wrong.
In this case the title should be identical, but remove the guardianship. It’s still “Deceased name, for benefit of Daughter name” only the mention of you falls away. No check is cut, and the account number shouldn’t even change, really, just the titling.
You are right to be concerned, I believe it’s the former, “Bob (deceased) fbo Mike†should be the new title. The broker should be able to guide you on this.
One important point. The math of the RMDs continues from your mom’s numbers. i.e. you take her last year divisor and subtract 1 each year, no reset to your age/RMD divisor. Make sense, I hope?
My sister, age 66, died and left her IRA in equal shares to me, age 69, and my older sister. age 71. This IRA was a substantial amount.($250,000.00 each) My older sister died recently and I am named the only beneficiary of her inherited non-spouse IRA, which is in my first sister’s name plus my older sister’s name as beneficiary. Now, since I am a second generation non-spouse beneficiary, how should this IRA account be renamed,and can I continue taking distributions based on my older sister’s age since she already started taking her RMD’s. What options do I have for taking distributions from this second generation beneficiary IRA account. I started taking RMD’s from my half of the IRA account in my first sister’s name in 2011. Please adivise
Vivian – I believe the titling becomes Original Owner, Deceased for Benefit of Current Beneficiary. Check with the broker, they should be able to offer advice.
The RMD calculation does not start over. You take the Divisor Sis was using to calculate her RMD, and continue to subtract 1 each year. So you now have 2 inherited IRAs with 2 different RMD divisors to use. Remember to update both accounts to show new beneficiaries. And it would be kind to leave paperwork showing the RMD divisors they need to use. Unless, of course, it’s a charity.
Last, remember, RMD means minimum, not maximum. It’s ok to take more each year if you need to.
what were the rules in 2006 for inheriting ira and a 403b? could a child take them over a lifetime and not cash out or take them over 5 yrs. if not..what happens if the took lifetime distibutions and now it has it has been 8yrs?
i am beneficiary of a traditional ira (401k) IN INDIANA that was supposed to be disbursed 2 years ago but wasn’t (didn’t know of deadline); can i ‘rollover’ this account into my own ira directly or must i take it out, pay taxes and penalties and then invest it into my own ira?
Yes, so long as the child was a named beneficiary, and the account was kept with proper titling. This is one of the best reasons to choose a child as beneficiary, the current rules permit a lifetime stretch of the RMDs.
There are two ways to go:
(a) calculate the required distributions for the two missing years, take those withdrawals, pay the penalty and tax, and then take the regular distribution each year.
(b) withdraw the entire balance by the end of the 5th year. In which case, it’s tax due, but no penalties.
Question: There were no living beneficiaries to my mother’s IRAs. They therefore became part of her estate. They were cashed and distributed by the estate. The estate paid more than 30% tax on the IRAs. Did the estate pay too much?
Instructions for form 1041 show the tax table for trusts or estates. See page 29. It’s 35% for income over $11,650. In my opinion, the IRAs should have been distributed in tact, and you’d have had 5 years to withdraw the account down. At your rate. I’d take issue with the executor of the estate.
My dad died in Jan. 2013. He left his ~$10,000 ira to me and my brother equally. We thought the financial institution would send us an RMD, but they did not last year, so I think we need to pay a penalty on the money. Is it okay to withdraw it all now, in 2014, and pay what penalty for that next year? Thanks!
You can avoid the penalty for the missed withdrawal by withdrawing all funds by the 5th year. The balance is small enough, it won’t hurt your taxes.
So, for clarification, I do not need to return the form the financial institution sent to us? It asked how much federal income to withhold and then gave options of lump sum (taken by 12/31/14), transferring the funds to another institution, or periodic payments over __ years (annually, semi-annually, quarterly, monthly)?