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George F. Bearup, J.D. Senior Legal Trust Advisor

1-May-17

Inherited IRAs – Dispelling Old IRA Myths or Don’t Make Assumptions

There seems to be continued interest in gaining a working knowledge of IRA distribution rules. In particular it appears some assumptions that revolve around inherited IRAs  may not be quite as accurate as we would like. This confusion often occurs when we mix our regular IRA distribution rules with those distribution rules that apply to an inherited IRA. What follows are some of those irritating inherited IRA distribution rules that can trap  clients, meaning clients who are not the surviving spouse of the deceased IRA owner, who inherit an IRA. These non-spousal clients are referred to for simplicity as the beneficiary.

  1. No Rollovers: The beneficiary can never transfer the inherited IRA assets into an IRA that is established in their own name. Recall that the title to an inherited IRA must contain the name of the deceased IRA owner.
  2. No 10% Penalty: The 10% early distribution penalty will not apply to distributions from the inherited IRA, either regular IRAs or Roth IRAs, even when the beneficiary is under age 70.5 years. An IRA distribution on death is an exception to this ‘early withdrawal’ penalty.
  3. No 60 Day Rollovers: The beneficiary can never do a 60 day rollover from one inherited IRA to another inherited IRA. The inherited IRA assets can only be transferred in a trustee-to-trustee transfer, unlike a normal IRA owned by the beneficiary in his/her own name, where one 60 day rollover is permitted every 12 calendar months.
  4. No ‘Do-Overs’: Once the beneficiary receives a distribution from the inherited IRA he/she cannot put those funds into another inherited IRA. Instead they are taxed to the beneficiary who took the distribution.
  5. December Deadline Date: In order for the beneficiary to use his/her own life expectancy to stretch IRA distributions from the inherited IRA over the beneficiary’s life expectancy, their share of the inherited IRA must be created, i.e. segregated from other shares in the same inherited IRA, by December 31 of the year that follows the IRA owner’s death. If the separate shares are not created by that deadline, then the required minimum distributions from their share of the divided IRA will be governed by the life expectancy of the oldest beneficiary of the created shares under the single IRA.
  6. No Spousal Rollovers: If the beneficiary of the inherited IRA dies and he/she names their spouse as the next beneficiary of that inherited IRA, the inheritor’s surviving spouse cannot ‘roll’ the balance of that inherited IRA into an IRA in the surviving spouse’s name alone. The original IRA owner is treated as the owner, not the deceased inheriting beneficiary; consequently,  no spousal rollover is permitted from the inherited IRA even though a surviving spouse is the next-in-line beneficiary to take distributions from the IRA.
  7. Single Life Expectancy: Despite the fact that the IRS has three different life expectancy tables, the beneficiary of an inherited IRA can only use the Single Life Expectancy Table. See IRS Publication 590-B.
  8. Roth IRAs: There are required minimum distributions from inherited IRAs, even from inherited Roth IRAs. While the Roth IRA owner does not have to take any required minimum distributions, inherited Roth beneficiaries must follow the rules that are prescribed for designated and non-designated beneficiaries, i.e. the Single Life Expectancy Table. One advantage to an inherited Roth IRA deals with the 5 year rule. In general a distribution from a Roth IRA is take free, but only if the Roth has been in place for at least 5 years. If the Roth has been in place less than 5 years, some of the profits earned by the Roth during that initial period will be taxable if distributions are made from the Roth IRA. If 5 years have passed, then distributions from the Roth are not taxable to the recipient- the first dollars coming out of a 5+ year Roth IRA are a return of principal, not income earned. If a Roth IRA has been inherited, the beneficiary does not have to re-start a new 5 year Roth holding period. The beneficiary may ‘tack-on’ to the years the Roth existed in the hands of the owner in order to satisfy the 5 year minimum requirement for distributions from Roth IRAs to be income tax-free.
  9. Non-Designated Beneficiaries: [Stick with me on this one.] A non-designated beneficiary of an inherited IRA is when no beneficiary was formally designated for the decedent’s IRA. Consequently,  the IRA becomes an asset of the deceased IRA owner’s estate, and thus indirectly through probate distributions, someone becomes the owner of the decedent’s IRA. That person is a non-designated IRA beneficiary. In this situation, there are no stretch IRA rules. The distributions are instead governed by the age of the deceased IRA owner at the time of his/her death. If the IRA owner was under age 70.5, the maximum period the non-designated beneficiary can delay taking distributions is 5 years, meaning that the entire inherited IRA must be ‘emptied’ within 5 years of the owner’s death. If the deceased owner was over the age 70.5 and thus was taking required minimum distributions, then the non-designated beneficiary can continue with those required minimum distributions. For example, if the original IRA owner was age 80 when he/she died, their life expectancy was then 10.2 years. The non-designated beneficiary then can take required minimum distributions from the inherited IRA using the old owner’s life expectancy but using the single-life table, meaning each year thereafter the required minimum distribution is less one year, e.g. in the year following the deceased 80 year owner’s death, the beneficiary will take an RMD based on 9.2years [10.2 years less 1= 9.2 years.] This means that the longest possible payout using the Single Life Expectancy Table, if the IRA owner had attained their required minimum distribution age, of 15.3 years, i.e. based on an IRA owner age 71 at the time of death.
  10. Successor Beneficiaries: Assume that child inherits mother’s IRA. Child takes required minimum distributions using his own life expectancy. But child dies while taking required minimum distributions from his inherited IRA. Child names his daughter as the beneficiary of his inherited IRA. Daughter, the successor beneficiary of the inherited IRA, can only use her late father’s life expectancy following the Single Life Expectancy Table. She is NOT permitted to use her own life expectancy for her distributions from the inherited IRA.

In sum, use caution, but no assumptions, when guiding a client who inherits an IRA, as the required minimum distribution rules are not the same.