Non-spousal Inherited IRAs - 3 Tips to Avoid Costly Tax Traps

>> News Listing

Jan 01, 2018

By Todd Helle, EA Tax Director and Partner at Terry Lockridge & Dunn

Todd_Helle.jpg

While the death of a grandparent or a parent is very sad, if you do end up receiving an inherited IRA, do not just cash out the funds. It will cost you in income taxes if you do!

There are several options for traditional non-spousal inherited IRAs, depending on the decedent's age at the time of death. An account owner over age 70½ is required to begin receiving required minimum distributions (RMDs) from the account by April 1 of the year after he or she reaches age 70½ (the required beginning date). If the decedent had already passed the required beginning date, there are just two choices:

  • Taking a lump-sum distribution of the entire balance; or
  • Rolling the inherited IRA over into a new account and taking distributions over the longer of the life expectancy of the beneficiary or of the decedent.

If the account owner died before reaching the required beginning date, the beneficiary has a third option of withdrawing all the funds in the inherited IRA account by the end of the year containing the fifth anniversary of the decedent's death. This is called the five-year rule. In addition, under the second option, the life expectancy of the beneficiary must be used.

If the inherited IRA was a Roth IRA, the RMD rules for decedents who died before reaching the required beginning date apply.

Here are 3 tips to consider to avoid costly tax traps:

Make sure the new inherited IRA is titled correctly.

An inherited IRA must be titled with both the name of the decedent and beneficiary and must indicate that it is an inherited IRA by using words such ‘inherited’ or ‘beneficiary.’ Here is an example of correct titling: "Jane Doe, deceased (insert the date of death), F/B/O (for benefit of) Jimmy Doe, beneficiary." If you put the IRA in only the beneficiary's name, it will cause it to be treated as a distribution of the entire balance in the IRA subject to taxes. Retitling the account is best done at the brokerage where the decedent held the IRA before the beneficiary rolls it over to his or her own brokerage.

Check that the decedent took any required RMDs in the year of death.

If the decedent was over 70½ and died before taking the annual distribution, you must take their required minimum distribution before the end of the year, or else there is a 50% penalty, and you are still required to take the distribution.

Pay attention to statutory deadlines.

Under the life-expectancy method, the first RMD must be taken by Dec. 31 of the year after the decedent's death. This is also the deadline for electing to use the five-year method if the decedent was not yet taking distributions.

Please contact Todd at thelle@tld-inc.com to discuss your specific situation, or any of the accountants at Terry Lockridge & Dunn. We can be reached at 319-364-2945 in Cedar Rapids, or 319-339-4884 in Iowa City.


Category: Featured