All Things Financial Planning Blog

185 thoughts on “What To Do With My Inherited IRA

  1. Do you think the loan mod program can actually save the US real estate market? Isn’t job growth the most important answer for stimulating a local market?

    • Sharyl

      You have raised good questions. I think it takes both things to occur in many parts of the country.

      The loan modification program can help people stay in their homes; this has the effect of keeping these homes off the market. In turn this helps people who need to sell their homes because of job changes or need of downsizing to a smaller home to be able to sell their home.

      This also helps the pricing side of home sales because we do not have the distressed homes on the market causing deflated prices for all homes. This is not an issue in all parts of the country but it is surely hurting the distressed states with high unemployment.

      Job growth is very important for the entire economy. Without a job people have less to spend on all items, so we need to get people back to work. When people are working they can meet their mortgage payments and they can stay in their homes rather than be faced with foreclosure and forced moves to other places to live.

      As you can see, I do not believe it is one solution only to turn our economy around to the growing, vibrant behavior we had in the past. What we do need to avoid is the economy in all aspects moving too fast in any sector such that we have no ability to sustain the growth that occurs.

  2. Francis,
    Appreciate your blog. Question…if your client Lucy disclaimed the Inherited IRA as you mention, wouldn’t her father’s IRA get distributed to whomever he had named as contingent beneficiary of his IRA? This could be Lucy’s child which would be great but if not, and none was named, it would be an estate asset, and subject to his will if he had one. If no will, then it would be an estate asset and subject to the state intestacy laws, I believe, which may or may not include Lucy’s child. Appreciate your feedback on this one. Thank you,
    Steve

    • Steve F

      I am glad to see you have an interest in my blog, thanks.

      The inheritance of an IRA and the questions related to disclaiming an interest in the IRA are quite complex. Your questions and comments are also right on point. Implied in your thoughts is the importance of having a good estate plan and not leaving it to the intestacy laws of the state. Those laws may not be what you intend or want, so having the correct beneficiaries named is very important.

      In disclaiming an interest, the contingent beneficiaries named would be the ones who would be eligible for the distributions. In Lucy’s case, her children if they were the named contingent beneficiaries.

      If there were no contingent beneficiaries named, then we would look to the other documents that exist – a will or a trust. If these documents exist then they would guide the direction of who would get the distributions.

      In Lucy’s case, it would be very important for her to know who was going to get the inheritance so there would not be any unintended consequences. My suggestion to Lucy to consider disinheritance was to accomplish several things. The primary one was to limit any income tax liability because the money would be going to someone in a lower tax bracket than what she would be in. The second was to help protect these assets should she decide that she needed to file bankruptcy because of her other financial issues.

      It would be very important for anyone considering disinheriting any asset to consult an attorney who specializes in wills, estates, and taxes to be sure that all issues are reviewed before making any decisions in this complex area. The IRS has issued many private letter rulings over the years on these very matters which suggests that this is a complex area of tax law.

  3. What happens if Lucy disclaims all or part of the IRA and she is not the sole primary beneficiary? Would her “portion” then be split up among the other primary beneficiaries or will her portion go to her off-spring – does it matter if her father had named the primary beneficaries per stirpes or per capita?

    • David G

      First, thanks for your comments. See the comments I posted on Steve F’s questions on the same topic.

      Lucy would be disclaiming only her interest in the IRA and would be doing so for the purpose of having that money get to the beneficiaries she intended to assist. These would be the contingent beneficiaries named in the IRA to make things easy, thus the importance of naming the primary and contingent beneficiaries on your IRAs.

      As I indicated to Steve, this is a complex area of tax law that has resulted in several IRS private letter rulings. While private letter rulings are intended only for the persons who requested the rulings, they do provide some directions for others faced with similar situations.

      I would encourage anyone who has the technical questions you are raising about per stirpes or per capita to consult with their attorney about the particulars of their situation.

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  5. If Lucy was already in the 28% tax bracket when she inherited her IRA, given the current economic climate and the potential for taxes to increase even higher in the coming years, what would your advice to Lucy have been?

    • Molly

      Sorry I have not responded earlier to your post but let me provide some thoughts on your excellent question.

      What tax bracket Lucy would be in further on in her life is a function of many things, one of which would be the tax bracket she will be in each year. This will be based on what her income is each year and the types of income. For instance, when she starts receiving social security benefits, that income may not be totally taxable income (just like today it is not totally taxable income).

      As such her tax rate may be lower in the future.

      What is important to keep in mind on the minimum distributions is that this is exactly that “minimum”. More than the minimum can be taken out in any year, so good tax planning would result in lower taxes ultimately even though the tax bracket rates might increase.

      Hope this provides some insight to your very good question.

      Francis St.Onge

  6. Hello

    I was reading your posts, and have almost the same situation.
    I have an inherited Ira, and Irra in the same financial investment fund, my father also had started taking Required Minimum Distributions (RMD) because he was 75 when he died. I am currently working, and saving some money in my retirement account with a different fund manager.
    I basically want to keep the same fund for my retirement, I am 49. What is the best way to keep it growing ? Will I have to take the RMD every year if I roll it over into an inherited IRA with the same fund he was using? I am single and do not have children. There is approximately $300,000 in the fund.

    Thanks,
    Joe S

    • Joe

      Sorry I did not respond to your post earlier, but let me cover a few issues you identified.

      An inherited IRA can not have any new money put into it, it can only have minimum distributions taken out each year. It is important to take that minimum distribution each year as there are penalties for not doing so.

      As for what you have this money invested in, there is no reason that you could not use the same mutual fund in both IRA accounts.

      As for the money in your retirement account, you will have the ability to consider converting some or all of that account into a Roth IRA once it is rolled into an IRA after you leave your employer because you leave or retire. This conversion would require that taxes be paid on the amount converted, so this is something that requires some planning to minimize the tax burden.

      One last point, you are not able to convert the inherited IRA into a Roth IRA under the present rules.

      Hope this was helpful information.

      Francis St.Onge

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  8. Can money in an inherited IRA be used without penalty of later taxation toward a first time mortgage? What about helping to refinance on a property for the first time (aka. coming in to another’s mortgage (jointly) and refinancing)?

    thanks

    Rachel

    • Rachel

      Good question regarding the penalty aspects for an inherited IRA.

      The rules related to inherited IRAs require that a “minimum” amount be taken out each year. There is not a limit on taking more than the minimum each year.

      The distribution would be subject to being included in your taxable income for the year of the distribution, but no penalty is assessed for doing so.

      The rules you are referring to relate to money you might have in an IRA that you established and contributed to or to an IRA that resulted from you doing a rollover from a tax deferred account that you had with a former employer.

      Hope this helps.

      Francis St.Onge

  9. Hello,
    I have beeen reading your posts and have a queston. I am to inherit an IRA account from my mother who passed away 11-23-10. Nothing has been done yet. Value $73,000. I do not want to take this personaly ( I am an only child 61 years old) so if I disclaim the amount since she has no contingent beneficiaries can it then go into her estate? The assets of her estate are to pass to me in a Protection Trust that will be established upon probate. Then could the estate trust take or use the funds either immediately or over several years and/or reinvest it and either pay the taxes or distribute funds that fall under the reporting rules? My goal here is for me not to take any taxable funds personally, but allow the trust to deal with the tax burden. I aprreciate your thoughts.
    John

  10. John

    Thanks for the question, which is a very good one. What you are suggesting may be an option but I am not sure you will want to follow that course of action once you have all the facts.

    I am sorry to hear of your loss, my condolences to you and other members of your family.

    The good news is that you do not have any decisions to make in the near term related to who is the ultimate beneficiary of this IRA. I am assuming that your mother was taking minimum distributions each year. If she did not do so this year, you may have to do that but the rest of the issues identified below need to be addressed before you make a final decision related the disclaimer you are thinking of doing.

    I am going to suggest that you consult with a local attorney and a tax professional who specializes in trusts and IRA beneficiary options. There is additional information needed to properly provide you an answer, including the following types of data:

    1. How big will the size to the trust be once all assets are properly valued for estate purposes? As you may know there is no estate tax this year, but there are capital gain issues to deal with.
    2. Besides you, who else will be a beneficiary of the trust, including after your demise?
    3. The period of withdrawal for a trust being the beneficiary of the IRA may be much shorter than the period you would have to withdraw (which is your estimated life per IRS schedule).
    4. While the minimum withdrawal that you would be required to take each year would be subject to being taxed, the tax liability would be based on what other taxable income you will have each year. This may be different than what the taxable income of the trust will be.
    5. Your income tax rate may be lower than what the trust tax rate will be, which means that it would be better for you to not disclaim your interest in the IRA.
    6. With an inherited IRA you will also be able to name a beneficiary in the event your life is shorter than the life expectancy provided by the IRS for your lifetime.

    There will be other issues that need investigation once this and other issues are identified by the professionals you get involved.

    I hope I have provided you with a starting point to figuring out the correct course of action in your particular situation.

    Francis St.Onge

  11. Thank you for this blog entry, it has been one of the most straight forward explanations of what can oftentimes be a complex subject.

    I inherited an IRA from mother when she passed on in 2000 and have been receiving rmd payments of about $1600 each December since then.

    I’m wondering if I can increase that rmd for 2011 and then drop it back down the following year? I understand that some tax planning will need to be done to insure the increased income doesn’t push us into the next tax bracket.

    Are there limits to how much one can take in an rmd each year from a rules/regulations standpoint?

    The long and short of it is we have been out of debt for a number of years now save for 50K left on our mortgage. I would like to stay debt free and not take on loans and such.

    However, we are in tight times now with only one income and we need to purchase a used vehicle for my wife at about $10-12K. I can take this out of our regular savings account but that would eat into our 1 year emergency savings, or I could possibly take it out of my inherited IRA by increasing the rmd for 2011? Not sure which is the best way to go on this.

    You mentioned the IRA is protected in the case of a bankruptcy as well as the equity in ones home. I have a 401K and my wife has a deferred compensation plan, are these also protect in the case of a bankruptcy? What about regular savings accounts, are they fair game in bankruptcies?

    Thanks

    • Ben

      First, thanks for the compliment on my blog, very much appreciated.

      You have asked some great questions and bring together a number of issues that need addressing.

      On the RMD, the key word is minimum. You need to take out at least that much but you can take more than that in any year. In fact you could cash it all in at any time. Just need to be able to pay the tax man in the year you do that.

      As for the bankruptcy question, it is protected up to $1 Million.

      Now for your 401k and your wife’s deferred compensation plans. This year, 2010, is a special year for such assets to be considered for conversion to a Roth IRA, especially if your adjusted gross income is over $100,000. If you were able to get the 401k and deferred assets into an IRA or if you have IRAs in addition to the 401k assets, you can convert these to a Roth IRA.

      As for the tax reporting on these conversions, you have the ability to elect to report the taxable income on the conversion amount for this year in either 2010 or to split the amount and report it on 2011 and 2012 tax returns. Since both of you have 401k type retirement funds, you could elect to report one of the conversions (say your wife’s) in 2010 and then split the other (say yours) into 2011 and 2012. I know this sounds confusing, so I would suggest you contact you tax professional to get help on this.

      What this conversion does for you is 1) stops all RMDs on the Roth funds when you become age 70 1/2 because Roth IRAs do not require such RMD amounts, 2) you eliminate all tax on any future growth on the amount that is converted to the Roth IRA, 3) after 5 years, you could take a withdrawal from the Roth IRA with no tax consequences. On the negative side, you need to be able to pay the taxes on what is converted on the tax return that you report the converted amount. This could be as late as April 15, 2013, for the amount to be included on your 2012 tax return. So with good planning, you could be spreading the tax burden on the conversions over three tax years. Just need to be sure to have the conversions done before December 31, 2010.

      If your AGI is below $100,000, you are able to do some conversion to a Roth IRA every year, even after you start the RMDs on your 401k after age 70 1/2.

      As for how much to convert, you can convert as much as you want. You are not required to convert the entire balance of your IRAs (or the 401k that you roll over to the IRA). Just need to be able to pay the tax.

      One final thought to bring everything together. You can not do this conversion to a Roth IRA on the inherited IRA from your Mother.

      Happy Holidays and good planning!

  12. My mother passed away 11/10. I am the beneficiary to her IRA for $50k. I am wondering which is better – to take all the cash out now this tax year and pay the tax consequence now or to roll it over to an inherited IRA and take out money each year and pay the tax consequence as I withdraw. My family and I have had a rough year financially and this money would be helpful now. Further, I believe our tax bracket will continue to go up as my husband’s salary increases. What do you suggest? Thank you, in advance, for your thoughtful advice.

    • Stephanie

      Sorry to hear about your loss, my condolences to you and your family. You have asked a number of very good questions and you have several options.

      First, you do not have to make any quick decisions on this IRA, the first distribution would not be required until December 31, 2011, at the earliest. However, you do need to be sure that your mother took her minimum distribution this year if she was over age 70 1/2.

      Second, the rules require a “minimum” distribution but there is nothing to stop you from taking more than the minimum at any time or in any year.

      Third, what ever amount you do take out would be considered additional taxable income to you and your spouse (assuming you are married) in the year you take it out. The key concern would to be sure that the amount withdrawn does not get taxed at a higher rate because you took out more than the minimum.

      Given how close we are to the end of 2010 and your comment about having some financial issues, you could take some out this month before December 31, 2010, and then take some more out in January 2011. This would spread the tax out over two years and might keep you in a lower tax bracket.

      As to how much you need to take out as the minimum, you need to get Table I of the IRA distribution tables from the IRS web site (www.irs.gov) in publication 590 to see what the correct period of time is for you should you want to spread the distributions out over your lifetime.

      You did not indicate how old you are, so it would not be possible to figure out what amount you are required to take out by December 31, 2011, but let’s assume you are 50 years old. A 50 year-old uses 34.2 years to divide into the $50,000 to get $1,461.99 as the minimum that would be required in 2011 as the distribution. You could take out more but not less. There are penalties for taking out less than the required amount.

      The following year when you are 51, you would use 33.3 years and divide that into the balance at the beginning of that year. As each year goes by the number you use will go down a little each year, by age 90 the number is down to 5.5 that is divided into the remaining balance at the beginning of that year.

      You also want to be sure to name a beneficiary for this IRA in case you should pass away prematurely. That person would then start with distributions at whatever their age is when they inherit this from you.

      Another issue to look into is whether the distributions from this IRA will all be taxable. It is possible that some of this IRA was a result of your mother making after-tax contributions to this IRA. If that were the case, then not all of what you take out would be taxable income to you.

      I would encourage you to talk to your tax professional or financial planner to be sure that you end up with the least tax cost to you regardless of what action you decide to take.

  13. My Mom passed away in Nov. 2010. My 2 sisters and I were beneficiary to her IRA. The bank called it a CD IRA.
    We each received checks for 2959.00. My mom was 87 years old and had taken out what she needed to every year since she was 70 1/2. Do we have to claim our share of the money we received? Would we have to pay a penalty? Any info you can give me would be gratefully appreciated.

  14. Sheilah Brust

    Sorry to hear about your Mother’s passing, my prayers are with you and your family.

    Since the bank has sent you the money, this is considered a distribution under the rules. As such each of you will also receive a Form 1099 for the year when the check was sent to you. This is one option that was available to you and it appears to be the bank exercised that option.

    While this will be considered income to you, the question of whether it will result in taxes is based on what other income you will have in either 2010 or 2011 depending on the date of the check.

    You will also want to review your mother’s tax returns for the past several years to see if she was having to pay tax on her entire withdrawal each year, look for Form 8606. If some of her IRA was from non-deductible contributions she made to the IRA then that portion of each withdrawal would not be taxable, only the earnings from the IRA would be taxable. The bank might also be able to help with this answer.

    You did not indicate if the amount you were receiving was the entire balance of your Mother’s IRA or just a portion. If there is a balance left in this IRA, I would suggest you contact a financial planner to assist you in moving this IRA to another trustee who will allow you to take distributions over your life-time, if you do not wish to have the entire IRA distributed at this time. This is one option that you have and by taking a minimum amount each year, the balance will continue to grow from earnings in the future.

    I would also mention to you that you may have a tax return to file for your Mother to cover the period of January 1, 2010, to the date of her passing in November 2010. If her estate had assets that generated income after her death that was then distributed to you and your sister or others, then there might be a tax return for the period from the date of death to the end of the year.

    If you do not have a tax preparer, look in your area for someone who is an Enrolled Agent (EA). They are authorized to represent taxpayers before the IRS and they prepare and file tax returns.

    I hope this provides you the information you need, if not let me know and I will provide additional help.

  15. My father passed in December 2010. I am an only child and the recipient/executor of his estate. He left three grandchildren a cash sum each and the balance to me in his will. I am also the beneficiary of his IRA which amounts to $156K. There is not enough cash in the estate to satisfy his will to the grandchildren. I have been advised by a CPA to: “disclaim the IRA and let it go to the estate as this will add the cash needed. Since I am the sole heir to the estate, the balance of the IRA cash will be mine anyway and the tax burden will be upon the esate and not me.” I cannot find information on this exact situation anywhere. I don’t want problems especially with the IRS. Did I get sound advice or not?

  16. Vern

    Sorry to hear of your Dad’s passing, my prayers are with you and your family. Thanks for your inquiry. There are a number of issues to address, not just the disclaimer issue.

    From what you wrote it sounds like the major asset in the estate is the IRA. That being the case you may need to do some analysis to figure out how to satisfy the will provision.

    You could disclaim and let the IRA pass to the estate but I think you should look at some other options also. There is not enough information to give a precise answer here but I can give you some ideas.

    As the beneficiary of the IRA, you are required to take minimum distributions each year, emphasis on the “minimum”. You can take more but not less based on your age each year. You may have to discuss with your attorney, but you could take out the amount needed to cover what the grandchildren are suppose to get to satisfy the will provisions. You would be responsible for the tax on the distribution but then the balance of the IRA would still be to you and the only requirement would be minimum distributions by you in the future years.

    You might also look at disclaiming a portion of the IRA to provide for each grandchild to get the amount they were to receive as an IRA. They would then be subject to the minimum withdrawals based on their ages which would be much less of a withdrawal for them then the amount you would be taking out to pay them.

    With respect to the tax burden being to you or the estate, I think you will find the tax burden to be higher through the estate versus for you, but that is a separate analysis taking into account your tax status now and in the future.

    By disclaiming to the estate, you could end up with the estate being open for a number of years, not sure you want that. I would suggest you find a financial planner who specializes in taxes as well using the FPA web site to find one near you. If you can find one who is also an Enrolled Agent (tax professional) that would be even better.

    As an inherited IRA, it will stay that for your lifetime, this is not one that could be converted to a Roth IRA. Be sure to name new beneficiaries for this inherited IRA as you so desire to provide for an orderly transfer of the balance upon your demise.

    Since your Dad passed in December, you have two tax returns to deal with. The first one is for the period up to the date of death using your Dad’s SSN and including all income up to the date of death. The second is to cover the period from date of death until you close out the estate, which requires a new number for the estate that you can get from the IRS. If you do not want to do this yourself, the planner or EA that you find can help with this.

    You did not mention this, but you may want to inquire with the holder of the IRA to see if your Dad took his minimum distribution for 2010. This may be something that is still open and needs to be done to keep clear of any issues on this item.

    If you have additional questions feel free to contact me and I will see what I can do based on having more information.

  17. Hello,

    My father passed away and left a will that leaves his estate to his five children, including me.

    He made my sister and me the executors.

    He also left my sister and me the beneficiaries of his $100,000 IRA. We believe it was his intent to share it with our siblings. We want to share, equally, the IRAs with our siblings and looked into disclaiming a portion of the IRA. So I am going to disclaim 60% of my share, and my sister will disclaim 60% of her share, so that we each receive $20,000. The question is, does the remaining IRA go into the estate account, and can our remaining 3 siblings now inherit the remaining IRA because they are beneficiares of our father’s estate?

    Thank you.
    Mary

  18. Mary

    Thanks for your question, which is a very good one. I am sorry to hear of your father’s passing, my condolences to you and your siblings.

    You may have to talk to the trustee holding the IRA as well as to your lawyer to deal with what is in the will and any other estate documents that exist.

    But based on the facts you presented, I believe you can disclaim a portion of what you are inheriting (as can your sister) with the intent that the disclaimed amounts will be going to your siblings. This should be a paper type transaction, meaning you should only have to prepare the needed form and sign it to accomplish what you want. There should be no tax consequences to you or your sister for doing this.

    The reason I am suggesting a discussion with the trustee is because the trustee may have it own procedures to follow which may require a different process. This leads to why you may want to have the same discussion with your attorney to be sure that what you want gets accomplished.

    Assuming the transfer gets done by disclaiming, then each person who receives their share of the inherited IRA would be required to follow the rules relating to inherited IRAs on minimum distributions each year starting now.

    I would also be sure to check and see if the entire IRA is taxable or is some of this IRA considered “cost basis” and not taxable. If your father made contributions to a traditional IRA for which he did not take a tax deduction on his tax return in the year he made the contribution, then you have “basis” which is not taxable to the heirs. If this was an IRA from a rollover related to his work 401k or 403b account then the entire amount will be taxable to the heirs as they withdraw from this IRA.

    Lastly, remind each heir to name a new beneficiary of their inherited IRA to provide for seemless transfer to their heir in the event your siblings should pass before they take everything from the IRA they inherited.

    Hope this provides you with what you need.

  19. Francis,
    Thank you for taking the time to answer this question! I think you provided us with some very good direction and I will share this with my sister.
    Mary

  20. Mary

    Thanks for the compliment, glad to hear that the information was helpful. Much success in your pursuit of disclaiming to share your father’s legacy with your siblings.

    Frank

  21. Steve:

    My wife (now age 48) has an Inherited IRA dating back to October 2004 when her first husband passed away. Can she roll this Inherited IRA into my/our 401K Plan without penalty?
    That being the case, we could borrow against the money in our 401K at a low rate (much lower than the 8 1/2% that banks are currently charging) to pay for her children’s college tuitions.

    Doug P.

  22. Douglas

    Each 401k or IRA is a separate arrangement related to one person, so the inherited IRA your wife has is hers and cannot be mixed with any IRA or 401k of yours.

    As for her inherited IRA, it is treated as if she had contributed to it. This means she can have this converted to a Roth IRA, pay the tax, and then arrange to withdraw from it without any penalty.

    She would not want to take a loan from it or from your 401k for the reason you gave because the loan would have to be paid back with after tax dollars and then later when the same dollars would be taken out in retirement there would be taxes paid again on the amount withdrawn.

    There are other ways to pay for the college education like student loans or home equity loans that would allow the IRA investments to continue to grow for the years the children are in college and then make withdrawals to help repay the loans.

    Hope these comments address your concerns.

  23. Mr. St. Onge
    this post was very helpful and you could have been easily talking about me. The citation is almost exact. My dad passed away in Feb., I am the soul beneficiary of his 206,000 IRA. I was working last year but minimally, have been working on getting a mortgage modification and have a fairly extensive IRS debt due to years of freelance work my husband never paid taxes on. the difference is that he also left a house that before 2008 was thought to be worth approx 640,000, we are putting it on at 520,000, it could sell in 3 months or it could end up on the market for a year or more, so hard to say. the IRS has agreed that we are financially unable to pay them unless something changes. My understanding is that they can’t go after the IRA as long as I leave it just the way it is. Also, my dad named our children as second beneficiaries, to be split in half. If I disclaimed it would they be able to use it for college, my son is currently in 6th grad, daughter in 4th. or would they get hit with huge tax implications if they were to withdraw it for college. Would they be better off if I kept the 206,000 as an IRA for my retirement and put money from the hopeful sale of the house into some type of fund from which they would not have to pay significant penalty’s or taxes. And if so what would that be? Can I transfer money from the IRA into their 529s with no tax implications? thanks so much, Tracy

  24. Tracy

    Thanks for your questions and condolences to you and your family on the passing of your dad. Your dad has left you a very nice legacy from his many years of work and savings that you must be very proud of. Hopefully I can provide you some helpful thoughts on how you can utilize and preserve what he has given to you.

    Of all the comments I have received to date on the issues associated with inherited IRAs, your situation has provided the broadest set of issues upon which to provide some advice. I could not have created a better example to address some very important issues for anyone in a similar situation. I hope you find these ideas helpful. I am going to suggest upfront that you find a person in your area who is a financial planner with tax experience to assist you because of the complexities that exist in your case. You can start with http://www.fpanet.org and type in your zip code to find individuals in your area. I would suggest a fee-only planner who also does tax preparation.

    Let me start with summarizing the type of issues you have identified that need addressing:
    • Whether to have the IRA in your name or in your children’s name. There are differences in the annual amounts that need to be withdrawn each year.
    • Whether to have the proceeds of the house sale go to you or your children.
    • How to handle the past tax issues given the sudden access to wealth.
    • Whether to save for your retirement or use college funding for your children.
    • How to take advantage of the Roth IRA going forward when you and your husband have earned income.
    • What are the tax issues related to the IRA withdrawals based on who is taking the withdrawals each year. What are the tax issues related to the house proceeds?

    There are sure to be other questions that will be raised once the above issues are addressed but this gives you a start on what you need to deal with.

    You did not give me some information that would influence the my answers but I will assume your age to be about 40 and the two children are 12 and 10 today. I have also assumed that the IRA money would earn 5% annually going forward and, finally, that the IRS debt is not a huge amount.

    Let’s start with your dad. Since he died in 2011, you have a tax return for the period from January to his date of death to report what his income was for that period. You also have an estate tax return for the period after his date of death to report transactions related to his estate, which will require a separate tax ID number related to the estate. The sale of the house may create a capital gain or a loss which would flow through the estate tax return to your tax return or to other beneficiaries, if you are not the only heir of your father’s estate. Finally, for this blog, you may have to take a Minimum Withdrawal for him for 2011 if he was over 70 ½ and he did not take that withdrawal before he passed away.

    While you would appear to have two conflicting goals to address (retirement and education), you do know you will retire one day but you do not know if you will need money for education of your children. This is not to say your children will not go to college, just that there are reasons why the dollars may not be needed because they might get a scholarship or use loans/grants etc. to get them through college.

    As to who has the IRA, you or your children, the amount that is required to be withdrawn each year is different due to age of who has the IRA. For instance, if you have the IRA, the first year amount would be $4,725 but if your two children had it the combined amount would be $2,870. This means that the value over time would be better with your children than with you – not to suggest that you should disown your interest, more in that later. In future years the amount to be withdrawn will increase because the IRA value goes up and the %age each year goes up.
    The amount taken out each year is reportable as income for everyone (assuming here that the entire IRA is taxable). In your case, it would be income over and above any other income you would have each year, so the tax rate on that income might be 15% or 25% federal and maybe state tax as well. For your children, the income would not be high enough to be taxed today but as they grow older and the value of the IRA grows as well, they would be subject to taxes once they are adults and out of college.

    For instance, if the IRA grew at 5% annually and each person took out the minimum each year, the value of the IRA at the end of 20 years would be $200,000 for you and the combined value for the two children would be $400,000 because they are taking out smaller amounts each year. In that 20th year, you would be taking out $15,272 and the combined amount for the two children would be $19,500. As you can see, the issues and decisions do not get easier as we move along, which is why the need for the professional help.

    The question of disowning the inheritance goes beyond the IRA, it also includes the house and the rest of your dad’s estate which was not mentioned in your note. This suggests that you also need to have an attorney who specializes in estates and taxes to be part of your team. Since your children are not of legal age and we have no idea what their financial management skills will be like as adults, you have some issues related to the disowning as well as maybe a need for a trust for them for any money they might inherit from you disowning this inheritance. This makes it extremely important to get your team of professionals lined up before you tackle these issues.

    As for your tax issues, it is hard to suggest what solutions to pursue because you did not mention the dollar amount of the liability or the number of years involved. More importantly, is the amount owed the correct amount? In my experience as an EA (enrolled agent) representing clients before the IRS, the amount owed is many times incorrect, so I would start by having that checked by a tax professional – go to http://www.naea.org to find a tax professional in your area. This person may also be able to develop a different outcome with the IRS then what you can do by yourself.

    It sounds like you will also be inheriting a large amount of money from the sale of your dad’s home and other belongings. This is going to create future income issues to you in the form of interest, dividends, and capital gains if left in a taxable type investment portfolio. So in the future, you will want to make use of the Roth IRA for you and your husband to shelter this income. Each year that you have earned income, you can contribute up to $5,000 for you and $5,000 for your husband ($6,000 each when you reach age 50). Earnings on the Roth IRA are tax-free when withdrawn after age 59 ½. In addition, the annual contributions to the Roth IRA can be withdrawn at any time without penalty or taxes – this provides a way to help fund the college educations if you should desire to use this money for that purpose down the road.

    If you or your husband have self-employed earnings going forward, you may also want to take advantage of the retirement savings programs available to self-employed people like the self-employed 401k program. Using this will reduce the income tax burden each year thus helping to protect this money from being taxed.

    There are other issues that may arise as you review these thoughts but I think it is important to keep in mind that you are at a crossroads in your life. You have been blessed to have a father who was able to leave you a legacy that you now must manage. How you manage it starting with how you deal with these issues will have a lot to do with what type of legacy you create and leave for your children and, yes, grandchildren. The fact that you looked for this information, asked me for some advice, and hopefully will act prudently on the information in this response, suggests that your dad will be very proud of you as he watches how you manage this process. And your grandchildren, whoever they turn out to be, will equally be proud of your management of this legacy. And, most importantly, you and your husband and children will have enjoyed the fruits of this legacy over many years into the future.

    Good luck in your pursuits!

  25. Mr. St. Onge,

    I have been reading the comments and have a question that no one seems to be able to answer. My mother died in December of 2009. She left 2 traditional IRAs and 2 Roth Iras, a combined value of $40,000. There is also a matter of her house. My husband and I were living with her when she died and need to stay in the house. We wanted to disclaim our share of the IRAs and set up a loan schedule with my brother to pay him for his share of the house (his share would be $50,000). In speaking with one of the IRAs they said that I was the beneficiary of the one IRA but there was no beneficiary listed on the other. They gave me a form to relinquish my share (they said I could fill in whatever percentage) of the IRA I was the primary beneficiary on and that the executor of the estate (my aunt) could name my brother as the primary on the IRA w/no beneficiary listed. They said that there was no time limit to when we could do this and said that there would be no tax penalty to me but that my brother would pay taxes on whatever he withdrew. The other IRA institution said it could have been done but needed to have been done within 9 months (which we are way past now). Is the 9month deadline universal or only per financial institution. Its been 17 months and nothing has been done with these IRAs. My mother was 64 and did not have RMDs and my brother is 32 and I am 38. Should we have taken some type of distribution by now?

  26. Michele

    Thanks for your questions. Sorry to hear about your loss, my condolences to you and your family.

    Each of the four IRAs require that RMDs be taken each year following the death of the owner, however, there is a five year rule as well. If the RMD rule was followed, there would have been a need to take a distribution in 2010 to avoid the 50% excise tax on the amount not taken. Based on the your age and the total value of all the IRAs, the RMD in 2010 would have been $877. So the 50% tax would be $439 if we devised no remedy for this.

    The second rule, the 5 year rule, allows you to let the value grow for 5 years and then you have to take the entire amount out at one time. This would avoid the 50% penalty.

    Since there are 4 separate IRAs, you could use a different rule on each one and limit the penalty that would be incurred.

    As to taxing of the RMDs amounts, the Roth IRAs are not taxable at all. For the IRAs, you need to determine if there is any “basis” in the IRAs. “Basis” is the value of the contribution amount into the IRA when it was established. For instance, if the IRA was the result of your mother contributing $2,000 to an IRA which grew to $3,000 and she did not take a tax deduction for the $2,000 contribution, then the $2,000 is considered “basis” and is not taxable. Only the growth would be taxable. So if you took $300 out of the IRA, only $100 would be taxable while the $200 would not have any tax consequences to you.

    With respect to the $100 that would be taxable, this means you would have another $100 of income that would show on your tax return. Depending on what your tax bracket is with this amount added to your other income, you would be taxed accordingly.

    If the IRA was from a work related program like a 401k or 403b, the entire RMD amounts would be taxable because no taxes were paid by your mother when she made the contributions through her employer.

    If your brother was to become the beneficiary of all the IRAs, his RMD would be $778 compared to your $877. This is because he is younger than you and thus is required to take out less each year over his lifetime. These amounts will change each year as each of you become older.

    If you relinquish your interest in an IRA, there would be no tax consequences to you. So you could disclaim your interest in the IRAs and give that interest to your brother.

    With the IRA that has no beneficiary, the RMD may be calculated based on your Mother’s age rather than the age of you or your brother. Given the small value of the IRA, the amount would not be significantly different but it would be a higher amount using your mother’s age.

    Hope these thoughts answer your concerns.

  27. If you placed money in an IRA and did not get the deduction because you or your spouse had a defined benefit plan, is that money convertable to a Roth without tax and without adding to your income?

  28. Adam

    Thanks for your question which is a very good one.

    Prior to 2009, the answer would be based on what your adjusted gross income was for a year. If it was above $100,000 you were not able to do the type of conversion that you have asked about.

    The tax law changes passed in late 2010 changed this provision to allow everyone to convert an IRA to a Roth IRA. Any conversion to a Roth IRA has tax consequences, in your case the taxable amount will be the difference between the total value and what is the “cost basis” within the IRA.

    Let’s say you contributed $5,000 to a traditional IRA several years ago and you did not take a tax deduction on your Form 1040. Further assume this IRA has grown to $9,000 and you convert this $9,000 to a Roth IRA.

    The taxable amount will be the growth of $4,000 that is part of the $9,000. The $4,000 will be taxable at the federal and the state level in the year you do the conversion at your incremental tax rate.

    Future growth of this now Roth IRA will be totally tax free and none of the Roth IRA will be subject to the Required Minimum Distribution (RMD) rules that apply to an IRA when you reach age 70 1/2.

    Now assume you and your spouse had contributed to traditional IRAs for many years and the balances are $100,000 for each of you. In this case you have two separate IRA pools to look at. Further you need to determine the total “cost basis” within each of the two IRAs to determine how much will not be subject to tax.

    Assume your IRA has $40,000 of cost basis and your spouse has $50,000 of cost basis. If you both wanted to convert some of your IRAs, there would be two separate outcomes as to what is taxable.

    If you converted $20,000 of your IRA, 60% of it would be taxable because your 40% of the total value is cost basis ($40,000/$100,000).

    If your spouse converted $20,000, she would have 50% of it as taxable income because 50% of her IRAs total value is cost basis ($50,000/$100,000).

    In summary, you only pay tax on the growth of the IRA, you do not get to pick and choose which contributions you want to convert, and you do not have to convert 100% of all IRAs you have at one time. IRS Form 8606 is used to track this issue over multiple years.

    I suggest to clients who want to convert to determine what tax bracket they are in currently before any conversion and be sure that they want to pay that tax rate on what they are converting. For instance, if your incremental tax bracket is 25% and you have some of that bracket available before you start paying at the 28% tax rate, then convert as much of the IRA each year that will keep you in the 25% tax bracket.

    While you did not mention it, you also need to consider if any of the IRAs that you have are from a 401k or 403b from a previous employer that you rolled over to an IRA. If you have done this, then all of that IRA will be taxable if you convert it to a Roth IRA. You also have to include this IRA in the calculation of how much cost basis you have in all your IRAs to determine the amount of the taxable portion of any conversion you do.

    I would also point out that in your question was the suggestion that either you or your spouse have a pension plan from your employer. This suggests that you may be in the same tax bracket when you retire as you are now while working. This is because when you “retire” and start taking the pensions and your social security benefits, your income may be as much as what your taxable income is today. Should you not convert the IRAs to a Roth IRA you will be required to take the RMD from any IRAs you have once you reach age 70 1/2. This RMD will add to your taxable income and will be taxed at the incremental tax rate you are in at that time. The first year RMD will be about 3.8% of the total value of any IRAs you have which will include the amounts in your 401k/403b accounts at that time.

    So it is best to address this whole issue of what you have and when to convert or not to convert before you get close to “retiring” so you can choose how you want to be taxed on these assets for the rest of your life.

    While this sounds complicated (and it is to some extent), I would suggest you talk to a fee-only CFP (www.fpanet.org) or an Enrolled Agent (www.naea.org) who specialize in tax planning to assist you with the complicated tax calculations so you have the right answers to your many questions. These web sites will help you find someone in your area who can help you

    Feel free to post another comment if you have additional questions on this important topic.

  29. Will I be penalized for taking money out of my IRA?

  30. Carmen

    Thanks for your question but it is too generic to be able to provide an adequate answer.

    I would need to know what type of IRA it is, how old you are, and for what purpose you are taking the money out of your IRA.

    If you want to post another comment with this information I will be happy to help you out.

    You may want to review other posts that I have answered to see if any of those comments cover what your situation is.

  31. Mr. St. Onge,

    I came across your blog when researching the taxability of an Inherited IRA. My child (12) recently inherited a large ($600k) IRA in which no RMD’s were taken yet (owner was under 70 y.o.). In reading the responses above, you mention that the tax on the children would be non-existent or lower than that of a parent who disclaims it and passes it on to the child.

    My question is, wouldn’t the child be subject to the “kiddie tax” because this is unearned income and therefore taxed at the parents’ highest marginal tax rate?

    I would love to not tax the RMD’s at my rate if at all possible, but from what I read, it sounds like it is. The IRS doesn’t mention IRA’s specific on their site, just “any unearned income”.

    Thanks in advance for your reply.

  32. Tim

    Thanks for your excellent question. It points out the importance of having all information as it relates to a specific issue in order to come up with the correct result.

    You are correct in your assessment about the “kiddie tax” rules and the income being taxed at the parents tax rate. However, this is for a short period of time that will end when your child reaches age 18 or, if going to college, age 24. After that the tax rate will be what the child is in based on all income for that adult.

    In this case, the child at age 12 will be required to take out 1.43% of the $600,000, or $8,580. Each year the rate would increase reaching 1.56% at age 18 which would be applied to the balance at that time. The balance in the IRA should be increasing each year based on investment performance, so the amount that is reported on the tax return will increase every year unless the investment goes down when the markets go down.

    The amount of RMD is that, the minimum. The child can take out more than that in any year, so it would provide a great source of college funding or a down payment on a house at some time in the future.

    Another key issue to look into is whether there is any “basis” in this IRA. If the source of this IRA was from an employer plan like a 401k or 403b program then the entire amount will be taxable. On the other hand, if this was an IRA from the beginning and was based on the original owner making annual contributions to an IRA that were not deducted on the person’s tax return, then those contributions are considered “basis” which would not be taxable. See Form 8606 for the details of this calculation.

    Under the definition of “unearned income” are pensions and annuities. This would include the IRA, so it is unearned income by definition.

    Your child has received a tremendous legacy from the relative. Properly managed over the years, this will provide the child with a value far beyond the $600,000 that this IRA is worth today. As an idea of future worth, an annual return of 6-7% would not be an unreasonable expectation for the long term. With an RMD of 1.5% per year, the net growth rate would be about 4.5-5.5% each year. This would suggest that the $600,000 value should double in about 14 years to about $1.2 million. At age 26, the now adult would be taking out 1.8%, or $21,360 in that year. By age 40, this legacy could grow to about $2.4 million and an RMD of about $56,400 in that year.

    These numbers are not a guarantee or an assurance, they are to provide you with a sense of what the power of time and compounding can do to this money when properly managed. I would encourage you to interview a number of fee-only financial planners in your area to get their perspective of how to see this legacy grow as depicted above.

    For reference purposes, go to the IRS publication 590 for Table V to get the withdrawal rates for this inherited IRA that will apply to this issue. For a financial planner, go to http://www.fpanet.org to find ones near you. This web site will also provide you with questions to ask the financial planners you want to interview.

    Lastly, be sure to have new beneficiaries identified to inherit this IRA should something happen to your child.

    if you have more questions, feel free to post another comment.

  33. Thank you for such useful information on inherited IRAs. I think your earlier blogs answered a lot of my questions but I do have one more. My mom passed away in October 2010 and I am the sole beneficiary of her $575,000 IRA which was converted to an IRA-BDA in my name earlier this year. About a month or so ago, after speaking to our accountant and then to my mother’s financial planner (who we are continuing to use for this IRA), I opted to take RMDs for my lifetime (although I still haven’t sent in the paperwork!).

    When I spoke to Mom’s financial planner’s assisant at one point, I asked if Mom had taken her RMD in 2010 (she was 73) and she said she had not but didn’t offer any other advice/comments. At the time, I didn’t really question her but now after reading so much on inherited IRAs, I realize we probably need to do something.

    I’m a little irritated that Mom’s financial planner didn’t tell us about this in 2010 so we could have taken the distribution (without a huge penalty). He called once and left a message but never said the purpose of his call and with everything else going on, we didn’t call him back until January or February once we had an attorney in place to handle the estate. Could you give me some advice as to what I need to do to get this straightened out. Should the financial planner report it or should I discuss it with our accountant??? And, what’s the penalty?

    Thank you,
    Amy

  34. Amy

    Thanks for your question as well as the kind comments about the information available to you.

    An RMD is required and a penalty may be imposed by the IRS for not taking the RMD, however, there can be exceptions. I would refer you to Form 5329 and its instructions for the process to appeal any penalty that might be imposed.

    I would suggest you plan on writing a letter explaining what has occurred including indicating the the financial planner did not indicate or provide any assistance to resolve this issue. Further indicate that you are taking the corrective action by taking your Mother’s RMD based on her age as is should have been. Then ask that any penalty be waived because you have taken the RMD as soon as you realized that it had not been taken.

    You also mentioned that you had elected to take lifetime RMD for yourself. It would be important for you to appreciate that an RMD is required every year but you are not limited to that amount. You could take out more than the RMD if that was what you wanted to do, you just can’t take less without a penalty being imposed.

    If you need assistance with this entire matter, I would suggest you go to www. naea.org to search for an Enrolled Agent who specializes in tax matters to assist you. You may also want to visit the http://www.fpanet.org website to find other financial planners who are CFPs in your area to see what they can do to assist you with this issue and your other financial planning needs.

  35. Hi,
    My father passed away April 28, 2011. Legally, my brother is his only biological and legal child. My dad wanted everything split 3 ways between myself, and my two brothers. My dad did not leave a will for his wishes or plan anything out. So, my brother who is his biological son has to take responsibility. My dad had an IRA that was rolled over from my Grandfather for 90K and his own IRA worth 220K. Is there a way for my brother to roll each of these over into 3 separate IRA’s for each one?

    Thanks

  36. Tiffany

    Sorry to hear about your dad’s passing but thanks for your question. My condolences to you and your family

    Both IRAs will be governed by who the designated beneficiary is on each IRA. If the IRAs list all three of you as beneficiaries then it is a simple matter to have the trustee break the IRAs into separate ones for each of you – this would be the preferred handling for each person’s benefit.

    If only one person is named as the beneficiary, then the IRA belongs to that person. However, that person can elect to disclaim their interest in the IRA and allow others to be named in order to share with others. This is a tricky area so you may want to consult an attorney who specializes in these type of inheritance issues.

    You mentioned your father died without a will. I am assuming your dad had other assets besides the IRAs. If so, then the state you live in has rules that govern how his other assets will be shared with relatives. Again this is an issue for an attorney to address, particularly given the family relationships you are referring to as to who is a direct descendant of his.

    I wish I could be more helpful but this is really something to discuss with an attorney to be sure that the rights of everyone are being properly protected.

    If I can be of further help feel free to post another comment.

  37. Hello Mr. St. Onge

    In April 1984 I started a Traditional Ira with my bank. Eight per cent fixed rate with my first deposit being $1,000.00. Maturity date of July 5, 1985. I deposited 2000.00 in 1985, 1200.00 in 1987. In 1991 I transferred 1952.90 from another IRA. I never withdrew anything before the age of 59 years, 6 months. My bank sent me a letter recently saying they could no longer pay 7.75 wich they have paid since 1995 based on an agreement that I didn’t know until this year. They sent me a copy recently of a 1985 agreement, I’ve never seen, and it was changed to 7.75 in lieu of 8 per cent in April 1985, before my Maturity date of July 5, 1985. The bank or the lawyer has backdated a copy of my original certificate to show a maturity date of April 1984. I am now computing my account from 1985 @ 7.75 compounded quarterly, and am finding shortages as much as 25.00 per quarter. I was told to consult a tax lawyer about this but really don’t know who to consult. I would appreciate any advice on what to do to correct past bank errors, and know fraud was committed when the bank or lawyer backdated their copy of my original IRA,dtd April 5, 1984. Thanks.

  38. (My bank sent me a letter recently saying they could no longer pay 7.75 wich they have paid since 1995). Sorry, the year 1995 should be 1985. I did not catch this critical mistake in my earlier statement, although I did proofread it.

  39. Norma

    Thanks for your question. To have received a return of either 7.75% or 8% for 26 years is a very nice return given all the turmoil we have had during those years so you made a smart decision way back then.

    As for contacting an attorney, you should look up your state’s attorney listing in the phone book for the Bar Association and ask them for a recommended list of attorneys in your area who specialize in tax matters.

    If you are missing $25 per quarter, that would be about $2,500 for the entire time if my reading of your question is correct. It might cost you that much to engage an attorney to deal with this issue. I am not sure that you will necessarily end up ahead of the game if that is the case. But I would suggest you at least pursue this to see if you have any recourse.

    You might also want to contact the State Attorney General’s office to see if this falls under their jurisdiction.

    Good luck in your efforts.

  40. Thank you sir for such a clear explanation on the inherited IRA and how it can work best. I’ve been searching for days and reading different explanations for days and this is by far the clearest and best I’ve found. What a great job of taking a complex subject and making it simple to understand. We are now relieved and know how to move forward with our inherited IRAs from our mother. Thank you!

  41. Gina J

    Thanks for the compliments on my articles and responses, I am pleased to know they were helpful. Sorry to hear of the loss of your Mother. If you have further need for help, feel free to post another comment.

  42. exactly what i needed to know.. im just like lusy .. but i actually forgot all about my IRA i inheritted the beginning of this year from my father and now wanna know what thedeal is with it before i call about it.. prob just send in the papers they sent instead… my mothe rand sister keep saying i have to put the IRA in my own IRA and cant withdrawall any of it.. i dont think i have to….but then i did read in the booklet they sent that it depends on what my father chose… does getting a lump sum amount or any amount cashed out of it depend on what my father chose… but that wouldnt make any sense since theres a RMD

  43. exactly what i needed to know.. im just like lucy .. but i actually forgot all about my IRA i inherited at the beginning of this year from my father and now wanna know what the deal is with it before i call about it.. i’ll prob just send in the papers they sent instead atfer rreading this… my mother and sister keep saying i have to put the IRA in my own IRA and cant withdrawal any of it.. i dont think i have to….but then i did read in the booklet they sent that it depends on what my father chose… does getting a lump sum amount or any amount cashed out of it depend on what my father chose… but that wouldnt make any sense since theres a RMD

  44. Lucy

    Thanks for your question about taking RMDs from your inherited IRA. Based on the facts you gave me, I think the best way to respond is to quote from the IRS Publication 590:

    “Example: Your father died in 2009. You are the designated beneficiary of your father’s traditional IRA. You are 53 years old in 2010. You use Table I and see that your life expectancy in 2010 is 31.4. If the IRA was worth $100,000 at the end of 2009, your required minimum distribution for 2010 would be $3,185 ($100,000 ÷ 31.4). If the value of the IRA at the end of 2010 was again $100,000, your required minimum distribution for 2011 would be $3,289 ($100,000 ÷ 30.4). Instead of taking yearly distributions, you could choose to take the entire distribution in 2014 or earlier.”

    In summary, you have two options. One is to take and RMD every year for the rest of your life and be sure to name a new beneficiary in case you die before the IRA has been totally withdrawn. Or, two, wait five years and take the entire amount at one time. Unless you have some reason to want to exhaust the IRA at the end of five years and pay tax then on the entire amount then, my suggestion would be to take the RMD each year for the rest of your life.

    I would encourage you to consult your tax preparer before you make this important decision to be sure you understand how much of the IRA is going to go to federal and state taxes rather than get an unpleasant surprise when you go to have your taxes prepared next year when you file your tax return.

    You may want to review Publication 590 at the IRS web site – http://www.irs.gov to gain further information about inherited IRAs.

    I hope this is helpful and if you have additional questions feel free to leave another comment but be sure to provide a little more information about the value of the IRA and your age. The more information I have the easier it is to provide better advice.

  45. Mr. St.Onge,
    I have read your blog from top to bottom and have learned so much. Thank you for this excellent information! However, my question was not addressed and wanted to ask for your help. A friend inherited a $90,000 IRA earlier this year. They want to make a charitable gift and plan to use the IRA rollover provision. Is there any issue with using an inherited IRA, in the year it was given, to make this type of gift? Will it qualify as the RMD?
    Thank you,
    Craig

    • Craig

      I am glad to hear that the information has been helpful and you have raised a few new issues from what has been asked in the past. Let me try to break down the issues into several topics.

      If the IRA was inherited this calendar year, the first RMD is not required until next year if the person inheriting the IRA is not the spouse. If your friend is the spouse then the RMD is not required if the spouse is under 70 1/2, rather the IRA can continue to grow until the person reaches age 70 1/2. As always, withdrawals can be made but I will assume that this money is not needed to meet normal daily expenses.

      In order to make a charitable contribution from an IRA, the person doing so has to be over age 70 1/2 to get favorable tax treatment. If so, the trustee of the IRA has to do the transfer to the charity and the amount would not be taxable to the person making the contribution and there would not be any charitable deduction for the amount of the gift on that person’s tax return.

      Now, if the question is can the person take an amount from the IRA and make a charitable contribution from that distribution, the answer is yes but they would have reportable income for the distribution and would have a charitable contribution for the amount donated. This would not create any tax advantages in doing this two-step action.

      If the distribution was done as a trustee transfer to the charity, the amount would count towards the RMD for the year in which this was done.

      There may be additional issues your friend has which you have not raised. I would suggest your friend review Publication 590 at the IRS web site as well as consult their tax professional before they make any decisions to be sure they make the correct decision for their situation.

      Feel free to leave an additional comment if you have more questions.

      • Thank you for your quick response. The person inheriting is the daughter and is over 70 1/2. She is planning to have the check written directly from the IRA trustee to the charity. So I am understanding you to say that the IRA gift, if given directly by the trustee, should not be impacted by the fact it was just inherited this year and the RMD is not an issue in the first year. Is that correct?

  46. Craig

    Thanks for the follow-up and the additional information. Here is a succinct summary:

    You can make distributions directly to one or more charities from your traditional or Roth IRA, as long as you are at least 70 ½ years old when you transfer the gifts. Such gifts can be made without increasing your taxable income or withholding. Additionally, funds transferred from your IRA to a charity will NOT subject your Social Security income to higher tax levels, and will count toward your minimum required distribution (MRD).

    Yes, the trustee should be writing the check to the charity. Hope this helps.

  47. Mr. St.Onge,
    Thank you very much for all the wonderful and helpful information! I only wish my wife and I had seen this prior to December 31st, 2009, so we could have satisfied the five year rule for my mother in law’s IRA. Unfortunately, our broker at the time told us we didn’t need to do anything with the account and we’ve just let it sit. So my question is if there is anything to mitigate the sizable (50%!) penalty that the IRS appears to favor in this situation? My wife inherited the IRA in 2003 at around $40k and it’s now held as its own account. The account is listed as an Inherited IRA with my wife as beneficiary and is now around $48k. My mother in law died at age 63 and had not taken any distributions.
    My sincerest thanks for any direction you can give us.
    -LL

    • Larry
      Thanks for your comment and I am sorry to hear about your dilemma. I believe there is hope for you to not have to incur the 50% penalty but let me try to set the stage first.
      I am assuming your wife to have been about age 43 at the time of her mother’s passing. Given the value of the IRA of about $40,000 at the time of the death the RMD amount would have been about $1,000 the first year ($40,000/40.7 life expectancy). So in 2004, the first RMD of $1,000 was required.
      For this analysis, I am going to use $1,000 each year as the RMD but remember that this calculation needs to be done every year and the actual amount will change as a result. In 2005 through 2011, an RMD of $1,000 each year would have been required. So a total of $8,000 would have been taken out if the process was followed per the rules.
      There are several ways to go about getting the penalty waived. One way would be to file for a private letter ruling from the IRS, setting forth the reasons you are asking for the waiver of the penalty – you got bad advice from the broker who told you to do nothing (hopefully you have this in writing). If they approve your request then you would have what you need.
      A second approach would be to take out the $8,000 (make sure this is the correct amount for all years) this year before the end of December. When you file your 2011 tax return, you will include Form 5329 and use Part VIII and report amount on line 50 and 51. Per the Form 5329 instructions, on line 52 you will enter RC and the amount to be waived in the dotted line section of this line. You will need to attach an explanation for the waiver, including the following thoughts:
      1. You were provided bad advice by your broker who said you did not need to do anything.
      2. You corrected for the over sight as soon as you learned of the problem by taking out the cumulative amount that should have been taken out each year since the mother’s passing.
      3. I would include a schedule that shows how you arrived at the amount you take out in 2011 showing each year’s amount in the schedule, the value of the IRA each year and the life expectancy value for each year.
      I would encourage you to engage a qualified (EA) tax preparer in your area to assist you in getting this done correctly. This EA can also represent you before the IRS to get this resolved as well as prepare your return.
      If your broker actually put this advice in writing back several years ago, I would talk to the broker about paying for any penalty you are assessed by the IRS if you are not successful in getting the penalty waived.
      Once your return is filed for 2011, if the IRS accepts your explanation for having the penalty waived, you may not hear anything from them. If you pay the penalty with the return, then you should get the penalty amount refunded to you.
      Hope this provides you with what you need to solve your problem. Good luck.

      • Thanks for your sage advice on this. It looks complex enough that I’ll take your recommendation to find a CPA locally to help us get it right. Best to you.
        -LL

  48. Frank, Thanks for writing your blog; lots of interstebing stuff going on here.
    I do have a question.
    My wifes mother passed away 2 weeks ago. Her father is still alive and is 93. Some of the IRA’s were in the mothers name, but in money markets earning almost nothing. We would like to move the money, but wonder about the penalty and timing. If we could just move it to another account for Pop to earn a little more, could that be done without penalty? Does a RMA have to be made regardless for 2010 since he is still alve, or can he just choose his RMA amount from another source for the year.
    We just dont want it to all go to taxes right now, and he really does not need the money.
    As a surviving spouse, does he still also get her SS monthly benefit?
    Thanks for your help
    Phil

    • Phil

      Sorry to hear about your Mother’s passing, my prayers are with you and your family.

      The IRA’s that were in your Mother’s name will become IRAs of your Father going forward and will be subject to the minimum withdrawal rules (RMD).

      The first issue is whether your Mother took an RMD in 2010. If she did not that still needs to be done by the end of this month. The trustee where the investment is can assist you with that.

      Next year your Dad will have to take an RMD that takes into consideration all IRAs that he has including those of his wife. He can elect to rollover this IRA into his name and it will be as if it was his all along or he can leave it in his wife’s name and take the RMD from that one.

      As long as he is taking the RMD amount or more each year there are no penalty issues to deal with. There may be tax issues relating to how much taxable income he has and his filing status. This year he will be filing as Married Filing Jointly (MFJ) whereas for 2012 and future years he will be filing as Single. This suggests that you should sit down with a qualified tax preparer, preferably an Enrolled Agent who specializes in tax preparation (go to http://www.naea.org to find one in your area), before the end of this month to see if there is an advantage to taking out more than the RMD from either of their IRA accounts.

      As for what these funds are invested in, there are no penalties for changing the type of investment that is being used to grow the value of the IRAs. Transferring the money from a money market account at one trustee to another trustee and changing the underlying investment are all tax free transactions as long as the transfer is by Trustee to Trustee and no checks are made out to your father in this process.

      The type of investment that should be used for someone who is in their 90s needs to be consistent with their needs. By that I mean is they need this money to live on and the amounts are significant (about 10% each year is the RMD at this point), then the investment needs to be relatively secure. If this money is not needed to meet living expenses then the investment could be invested in higher yielding and riskier type investments – but be cautious in trying to increase yield in these times of market volatility.

      One thing to consider would be to look at converting some of this money into a Roth IRA this year after looking at the tax situation I noted above related to filing status. This is another reason to consult the tax preparer who understands all these issues. For instance, if there is not a tax liability in your parent’s situation now because they do not have a lot of income subject to tax, you consider converting some amount to the Roth IRA up to the amount that would create a tax. This has the effect of reducing the amount subject to the RMD for the future because Roth IRA amounts are not subject to RMDs.

      Another issue to consider here is what will happen upon your Father’s demise. I know this is a hard issue to address given that your Mother has just passed away and I apologize for raising this now. But if there are moneys left upon your Father’s passing, the beneficiaries will receive it the way it is left. Money in an IRA will become taxable to the beneficiary, money in a Roth IRA will not be taxable to the beneficiary. Both type accounts will require RMDs going forward, it is the tax issue that will be important. The amount of the RMD for the beneficiaries may be based on the ages of the beneficiaries rather the ages of your parents, so this may be an important issue to review now (next six months or so) while you Father is alive.

      Finally, be sure to review who are the beneficiaries of all the IRAs of both your Mother and your Father to be sure they are the way he desires and is best for all concerned. This may require that you consult a certified financial planner (www.fpanet.org) where you can find a fee-only planner in your area to assist you with this.

      Now, on the Social Security question. When both parents were alive each was receiving a benefit under this program. Your Father will continue to receive a benefit but only one check under whichever work record provides the best benefit to him. The best advice is to contact the Social Security Administration to get the correct benefit paid to your Father. They have already been notified by the funeral home of your Mother’s passing, so any benefits she was receiving will be stopped. What needs to be looked into is what is the correct benefit for your Father.

      Hope this helps, if you have further questions feel free to leave another comment and I will be happy to respond.

  49. Frank,
    Thanks so much for your thorough response, it really helps. It is in fact as complicated as I thought it would be. I think our best course will to pursue the best resolve through a professional such as yourself, and I truly thank you for your advice.

    Phil

  50. I need help. My mother had an IRA when she passed away this year. She had asked for advise earlier intending that her three children inherit her IRA. She was advised to have my one sister’s name put on the IRA *she lived closest* with the intent of having my sister distribute the funds.

    Can my sister disclaim some of this in order to distribute it? For instance, the amount is 154,000 and the funds are to be distributed among her, myself and my brother…how can she do this without a huge penalty coming into play for herself?

    I really wish the person who adivsed my mother had made this easier. It was not intended by my mother I am sure for this to be dragged out OR for the one sibling to end up with such a mess to untangle. What are our options to minimize penalties while at the same time making sure the funds are distributed three ways?

    Thank you in advance for your suggestions in this matter

    • Confused

      Thanks for your inquiry and my condolences to you and your family on the loss of your mother. There are ways to accomplish what you believe were your mother’s desires even though that is not the way the IRA was set up.

      The rules are very specific in terms of what has to be done so that the IRA can be split between the children and not cause the money to be taxed immediately. The rules are impacted by state laws as well as federal rules and also include issues related to what may have been stated in her will and the rules of the trustee holding the IRA.

      Because of these complexities and the lack of information about the status of each potential heir, I am going to suggest that you would be better served to find a lawyer in the area where your mother resided who specializes in estates and IRAs to assist you. You can contact the local bar association for attorneys to get a list of attorneys who can help you.

      Since your mother just passed away, there is plenty of time to get this issue resolved to meet everyone’s needs. Just be sure to not take any money out of the IRA until the plan of distribution is agreed to by all.

      Properly handled, the IRA can be divided between each beneficiary as an IRA and then each beneficiary can elect to only take minimum distributions each year going forward or the person could take out whatever amount they want above the minimum. Any amounts taken out would be subject to being taxed at the tax rate of the person doing so.

      If your mother was over age 70 1/2 when she passed away, there would also be a requirement to take a minimum distribution this year or maybe for last year if one was not taken out then. So be sure to have this checked out as well.

      I apologize for not being able to be more helpful, but I am sure a local attorney will be most helpful. You could also try to find a CFP in your area who may know all the rules associated with what you need. Use the “Find a Planner” section of this web site for assistance.

  51. Thank you for your quick response. It is complicated as I am not living in the U.S. at the moment where she passed away and my sister is the only one living in the same state. She I suppose will be the one to seek out a local attorney as my brother does not live there either. At least I know there should be some vehicle where she can distribute to each of us as an IRA taking the burden off her to distribute actual cash with a huge tax penalty in her name.

    Then each of us could decide from that point what we wish to do with the IRA accounts in our own names. I don’t plan to keep mine there forever as it’ is highly awkward for me to do so. I am not retiring there either so it’s another consideration. EACH of our situations are different making it all the more necessary the funds are split.

    Not one person my sister has spoken to including a tax accountant has mentioned any way to split this up without her having to withdraw it and incur large penalties. That just doesn’t seem quite right to me. She is essentially wanting to get rid of two thirds of the IRA and distribute that to her siblings.

    • Confused

      Thanks for the followup and the additional information. Yes, you do have a somewhat complicated situation but not impossible to address.

      You are making an assumption that there would have to be a huge tax burden for her or that would impact you and your brother. With proper planning and patience, this can be accomplished over a period of time. What I am going to share is not necessarily the right plan because all the facts are not known but several options to possibly pursue.

      Keep in mind that whether she takes out the money or each of you take out the money each year, the amount withdrawn will be subject to being taxed. If all of you were in the same tax bracket, the tax cost would not be any different in totality. So your sister could take an amount out, pay the tax and then share the net amount with each of you. In that event each of you would be in the same place as if each of you took the withdrawal.

      For instance, when I am working with a client who wants to do a conversion of an IRA to a Roth IRA, I suggest that they convert as much as they can and still be in the same tax bracket they are today or may be in when they are required to take minimum distributions. So if your sister was in the 25% tax bracket and there was still $25,000 of income in that bracket until she moved into the 28% tax bracket, I would be suggesting she convert that amount each year and pay that 25% tax. In this case she would need about 4 years to withdraw all of the money that you and your brother would be entitled to receive ($100,000). I would be encouraging her to not take it all out because she should want to carry her portion into the future and grow while she takes out only the required minimum distribution each year for the rest of her life.

      Now, is this the right plan for the best interests of all of you? Probably not, but it gives you an idea of what could be accomplished if a CFP was engaged to assist you and your sister to get the best plan in place. Having a qualified professional assisting all of you to get the best result will be a good investment to protect everyone’s interests.

      When considering the tax rate to be paid, keep in mind that if the entire amount was withdrawn and taxed in one year, the rate might be 25% or 28% of the entire amount ($100,000) due to you and your brother. If the amount was withdrawn over a four year period, the amount would be a little higher because that $100,000 would be invested for a longer period of time. If it earned $10,000 over the 4 years, there would be tax of 25% on that additional amount. So the analysis might suggest that the entire amount ($100,000) due to you and your brother be taken out at one time, pay the tax, and then get the remaining $75,000 to you and your brother.

      Finally, some words of caution for all of you. This is not the plan, merely a thought or two on how one could proceed. I would still want to know a whole lot more about the tax situation of all three of you as well as the need for this money now versus later before I would finalize any recommendations to you. There may be a financial need that one of you may have that would suggest a different plan of attack for what to do.

      While you have expressed what your mother really desired, it is important to keep in mind that, unless there are documents to the contrary, the IRA was left to your sister and she can do as she pleases. I am sure she is a generous person and will do what is right based on what your mother shared with her but this is her decision on what to do.

      You have indicated that you do not desire to maintain your share of any IRA because you do not live in the US. The ability for this IRA to grow tax deferred over your lifetime that would require you to take out a small amount each year could result in a great way to build some wealth for your retirement. This means you should be sure that there is not a way to get the IRA portion transferred to you and your brother and not require the money to be withdrawn any sooner than required. Assuming you were about age 50 today, the required withdrawal would start at about 3% each year; at age 40 it would be about 2%. You could, for instance, ask for a private letter ruling from the IRS as to how to share the IRA with all three of you.

      There is also a 5 year rule related to when the money needs to be withdrawn. This would give your family 5 years to figure out the right solution and not subject any of the money to any penalties for not withdrawing the correct amounts. It also gives you a 5 year window of when to take it out because the tax situation for your sister might change allowing the tax cost to be less.

      I hope this provides you with some ideas that supports getting a financial professional to work with your sister to get the best results for all of you.

  52. Thank you for your blog and for your answers to the many questions people have asked. My mother passed away on November 7, 2011 and I was listed as beneficiary on two IRAs: one valued at 120K another valued at around 8K. I am only 26 and feel that it is in my best interest to keep the monies in the inherited IRA, allowing it to grow in value over my lifetime.

    After reading the above questions and answers it appears that I cannot place additional money into my inherited IRA, only take a required minimum distribution (or more if I prefer) out. Is this true?

    I would like to combine the IRAs or cash out the smaller account as it is currently being held at a large bank I wish not to do business with. Since I cannot add personal moneys into my inherited IRA does this same rule apply to combining IRAs held at different financial institutions? My husband and I do not need the 8K to live, so reinvesting it would be my first choice.

    Also, I have talked to my financial adviser currently managing the larger of two accounts; he suggests that I increase the risk associated with the investments since I am younger. If I am not able to add money in to these accounts, am I able to change how the money is invested without penalty?

    • Tricia

      Thanks very much for your compliments as well as the questions you have about the IRAs you inherited. My condolences to you and your family, you lost your mother much too soon in life.

      Lets tackle the issues one at a time. I am assuming your mother was much younger than age 70 1/2, but in case I am wrong you may have an RMD for her for last year if she was over 70 1/2. If not this is not an issue.

      For you, you will need to take an RMD each year going forward that will be based on two factors each year. One is the value of the two accounts at the end of each year and the second is the factor to use for your age. If you are 26 in 2012, the factor would be 57.2, if age 27, the factor is 56.2. You will want to get IRS Publication 590, page 86, which is the table of ages for your situation.

      Based on a value of $128,000 and the factor of 57.2, the minimum (RMD) amount you need to take out this year would be $2,238. Now this is the minimum, you could take out more. Now for 2013, the value at the end of 2012 will be divided by the factor of 56.2 to get the RMD for 2013. The year end value will be based on what you have invested the proceeds in and how the various markets perform for the rest of this year.

      While this RMD is taxable, you will also want to be sure you understand what the source of this IRA was for your mother. For instance, if it was her 401k at work then 100% is taxable income to you. If she was contributing to a Traditional IRA each year and did not take a tax deduction for that contribution, then she and you have a basis in the IRA that will not be taxable income. So you want to check on that.

      As to your next questions, you are not able to put more money into the inherited IRA but you are able to change what the IRA is invested in as well as you can move the IRA to any trustee you would like to use. The trustee could be another bank, credit union, mutual fund manager, or broker. That is your choice.

      Given you age and the fact that you do not need this money to meet expenses, I would be inclined to agree with your investment adviser on thinking about taking on more risk in what you are investing in with a long-term view of how this money can become your retirement program 40 years from now. See the end of my comments.

      Here are several other thoughts for you. If you adjusted gross income (AGI) is below $173,000 in 2011 and 2012, you and your husband can contribute $5,000 each to a Roth IRA for your retirement. Since it is not April 15, 2012, yet, you can still contribute to a Roth IRA for 2011. So if you wanted to fund this Roth IRA, you could close the smaller IRA and use it to fund your Roth IRA. You could also take an additional amount from the larger IRA in order to get the full $5,000 for both you and your husband for 2011. Now or later in the year, you could take another $10,000 from this IRA and use it to fund the 2012 contribution of $5,000 to both your Roth IRAs.

      If by chance, your AGI is above the $173,000, you could use a Traditional IRA rather than an IRA to make that contribution and then convert that Traditional IRA to a Roth IRA the next day. If you wanted to go down this path, it is important to take into consideration what tax bracket you are in when making this kind of decision. If your income is above the $173,000 level then you are probably also in the 25 or 28% federal tax bracket plus adding in the state tax bracket you are in. You will need to consider if that is a tax amount you want to pay for doing this. Keep in mind that you need to take out the $2,400 each year, so it is the amount above that which will create an added tax cost for doing what I am suggesting.

      Taking a longer range view of my suggestion, you might decide that paying a higher tax today on what you take out in order to get the amount into the Roth IRA where future growth will not be taxable when you withdraw from the Roth IRA 40 years or more from now may be a small price to pay today. Keep in mind that money in a Roth IRA is not subject to RMDs at age 70 1/2 like the money you may be saving in your 401k at work.

      Out of curiosity, I took a look at what would happen to this IRA if you took an RMD every year and earned 5% annually on what was in the IRA. By age 70, the value of what would be left in the IRA would be about $297,000. If you earned 6%, the value would be $461,000 and it would be $712,000 at 7%. The RMD at age 70 and the 7% return would be about $41,000. These are not guaranteed numbers so you need to have your financial planner fine tune what I have presented here so that you have a much better idea of how important your great idea is of not ignoring the value if this great legacy your mother has left you and your family. You should also have the planner run some numbers on what will happen to the Roth IRA contributions over the years – you are in for a very nice surprise!

      Actually, my hope for you is that your financial planner has already done this education for you. If not then maybe you have some evaluating to do of who is advising you on your financial plan.

      I would also suggest that you review what I have presented here with your tax professional so that he/she can refine what the tax consequences are for your specific situation.

      Finally, be sure that you have named a beneficiary for this inherited IRA so that this is not overlooked in the hectic times of your future.

      If you have other questions, feel free to leave a follow up comment.

  53. I will soon be the recipient of an Inherited Trust, money (transfer upon death) will be rolled from a traditional investment account into this, the value will be about $125,000. My question is this: Can it be rolled into a Special Needs Trust? I have a 4-year daughter with Down Syndrome, my grandfather passed just three weeks ago. He was 86 and had been taking the required RMD prior to this year. If I cannot roll it into a Roth, and I don’t want to take the money outright, what are my options? Will I be forced to take the RMD as well if I choose to leave the money as is for the next 5 years?

    • Lonna

      Thanks for your great questions, I continue to be impressed with the ideas that get presented by the readers of this blog.

      Lets do the easy things first. If your grandfather passed away in 2012, an RMD based on his age will be required before you do anything with the money going into the IRA you are inheriting. Second, you cannot roll this into a Roth IRA, it will be maintained as an inherited IRA for your benefit during your lifetime.

      Your question about taking it out in 5 years is only one of the options you have. Under this option, you would have to take the entire amount out at that time and pay taxes on the entire amount that is taxable at that time. I am not sure that would be the best result for you and your family because the amount would be taxed at a much higher rate than is necessary if you used the other option.

      The other option you have is to take an RMD each year based on your age today and using the Table in IRS Pub 590, page 86. Guessing at your age, I would suspect the factor today is about 50, or about 2% the first year for the RMD. That would be about $2,500 of taxable income to be added to your other income. When you take out that $2,500, there are no limits on what you can do with this money. Based on your situation, you could put that RMD withdrawal amount in the special needs trust for your daughter, buy something for yourself or your daughter, or put it into a Roth IRA for you assuming you have earned income of at least that amount and have not already made a contribution to your Roth IRA for 2011 or 2012.

      After that 2% RMD, the balance in the inherited IRA would grow so that over your lifetime, this money is going to grow to a big sum. See my comments to Tricia in my previous comments to her.

      As I am sure you know, children with special needs should not have money left directly to them as then you lose many benefits that are very valuable to you and your child. It is also not a good idea to have the special needs trust be the beneficiary of this IRA now or at the end of your life because the trust is not able to make the same decisions that a person can. So the beneficiary of the IRA you are inheriting should be a person not a trust.

      The trust question is one I would suggest you discuss with the attorney who has assisted you in the development of the special needs trust you already have or an attorney you would be contacting to set up a special needs trust.

      While you are required to take out the RMD amount each year, you can take more than that amount in any year you so desire. If you are not currently contributing to a Roth IRA for you and your spouse (assuming you are married), you might consider taking out enough each year to be able to fund those Roth IRAs ($5,000 for you and $5,000 for your husband assuming you have earned income from wages of at least $10,000). As noted for Tricia, you have until April 15, 2012, to fund the Roth IRA for last year. Y the way, this is how you get the money form the inherited IRA to a Roth IRA, you just need to take a little longer to get the job done.

      Why the Roth IRA versus leaving it grow in the inherited IRA? Because the future earnings in the Roth IRA will not be taxed whereas the IRA amounts will always be taxed. In addition, the amounts in the Roth IRA are not subject to the RMD at age 70 1/2 like amounts in a 401k/IRA would be.

      Finally, I would suggest you find a fee-only financial planner in your area by using the Find A Planner button at this website to refine the suggestions I have made based on learning more about your particular situation. For tax impacts you may want to look for an Enrolled Agent in your area by going to the http://www.naea.org website. An EA is one who is a specialist is tax rules and can assist you with what amounts would make sense to take out each year and keep the tax cost as low as possible. Be sure to have these professionals show you the long term benefits of each option I have suggested you consider.

      If you have additional questions feel free to leave another comment.

  54. Great blog very helpful..
    My question is this:
    My sister passed away in Jan 3rd 2011 at 61 she was 61 years old. I am the sole beneficiary of her IRA. It had apprx. 165,000.00 in value.. 29,000.00 of which was in a 6 month CD.. I was unemployed as an electrician in 2009 and 2010 and 2011. In February 2011 I had no choice but to use some of the IRA and I took out some of it… It totalled 69,000.00 in 2011 part of whch was the CD worth 29,000.00 which I took out in May of 2011.. Now that tax time is rolling around I’m concerned about where I stand as as far as a tax bracket. I have large credit card debt (still with a decent credit rating though, Thank God) and I also had approx 6,000.00 deposited into my checking account in 2011 in addition to what I had to use from the IRA/CD accounts.. Any ideas would be greatly appreciated. I obviously still have to get together with an accountant but would like to get and idea/s before hand.

    • Steve

      Thanks for your questions, I hope by now you are back in the ranks of the employed. If I am reading your comments correctly, it looks like you took out $69,000 from the inherited IRA. I am not sure what the $6,000 was but for this purpose let me assume it was income you earned. That will allow me to cover a few bases that may be important for tax purposes.

      If the $69,000 was all that was taxable on your tax return (meaning no unemployment income or other income), then about $60,000 would end up as taxable income after the personal exemption and the standard deduction if you are single. That $60,000 would create a tax liability of about $11,150 federal tax plus whatever the tax rate is for your state and local income taxes.

      If you were married, then I am not sure I can help because I do not have enough information. For instance how many children are you claiming, what income did your wife have, what itemized deductions will you be claiming on Schedule A, etc.

      Now, if the $6,000 was income you earned from odd jobs, then you have what is called Schedule C income and you will owe self employment taxes (FICA) of about 15% on the $6,000 (less if you have expenses to claim in earning this money), or $900. This would add about $5,400 of income on top of the $69,000 in the above calculation and this $5,400 amount would be taxed at 25%, or another $1,600 of federal income taxes.

      If these tax amounts sound like too much to handle at one time, the IRS might agree to a payment arrangement that can be requested at the time you file the tax return. See Form 9465 at the IRS web site for details.

      If you look for previous articles I have written, there is one about Form1099-Misc that gets many people in tax trouble because they do not prepare themselves for the shock of the tax bill when they get to tax time.

      Hope this helps you with the tax planning before you go looking for that Enrolled Agent near you to get your return done by a tax professional – http://www.naea.org. That EA will be sure that you end up with a correct, complete and well thought out tax return.

      If you have additional questions, feel free to leave another comment.

  55. My mother in law passed away April 2008, she was not taking RMD at that time as she was only 54 when she passed. All of her liquid assets; an IRA, a CD, and a regular checking account with SunTrust were payable upon death to my husband and her minor child (my husband’s sister). Upon meeting with the advisor at SunTrust we were given no options on her IRA. I believe was a traditional IRA. The IRA was divided and placed into 2 separate IRA’s as beneficiaries of her. As she left both children with a paid for home and a substantial amount of money in a pension and checking account our choice was to place the CD into a CD in our name together. However, we were told that we HAD to leave the IRA funds in an IRA in his name as beneficiary of her, and could not make another beneficiary on this IRA since it was beneficiaried to him. So, we did so and this IRA is set to mature in August of 2012. After the funds were separated amongst him and his sister, his sister’s money was placed in custody of the local probate court since SunTrust would not enter into a freeze agreement with us. He has been receiving his RMD every year since December 2009. I would like to take all of the IRA out this year when it matures as we are expecting a new baby and would like to use the IRA for a down payment on a new home. We do not wish to sell our other home as we are hoping to allow our oldest son to live there free of rent in the future, we are currently renting this home out (we are currently living with his sister at the home his mother occupied and was left to his sister). She will take control of her home soon and we will be free to move on. My question is, can we still take out the whole amount in August when it matures without penalty from the IRS. Sun Trust us telling me there will be a substantial penalty if the funds are removed prior to him turning 59…he is only 34 right now. I may not be of sound financial mind, but to place your money in someone else’s care and for that person to dictate when and how much of YOUR money you can use is not what I would with my money. Our CD has gained more interest than the IRA has since 2008 and there are no penalties to cash that in at maturity date. In my opinion, they are holding his inheritance hostage. I questioned them as to why he was not given the option to remove all of the funds of the IRA at the time of inheritance. And they told me that they do not know what that advisor had told us, but still stick to the idea that we had to leave the money there in an IRA and could not have taken it out at any time without penalty. Not to mention that they will not allow him to put a beneficiary on this account in case he passes. I am told a will would override that, and with the length of time it has taken to deal with his mother’s estate without a will, we already have one in place, but Sun Trust is telling me that this is not true, that even if he wills his IRA to me, that the fact that he inherited it will not allow it to be willed to me. I have had very unpleasant dealings with Sun trust over the last couple of years and would like to remove all of our assets from them….without penalty.

    • Jennifer

      Thanks for your question and sorry to hear the angst you are going through with trying to manage the inheritance. I will try to answer some of your issues but I am going to suggest you use the “Find a Planner” in the helpful links to find a fee-only planner with tax experience near you to really get at the solutions you need after reviewing more details of your situation.

      With respect to what you can do with this IRA, the first thing would be to find a trustee to transfer this account to who will work with you and allow you to do what you are legally able to do, starting with naming a beneficiary for this account in the event of the death of the current beneficiary of this account. The only “penalty” that your husband will pay if he takes out the entire amount is the federal and state income tax on the amount withdrawn (which could be substantial) but the age 59 1/2 rules do not apply to this situation.

      While your husband is required to take the RMD as he has been doing, he can take out more than the minimum in any year. I would be sensitive to what tax bracket any withdrawal would put this money in before you take anything other than the RMD out. In previous responses to other posts I have provided ideas on why taking more out now would be a good idea, like putting the proceeds into a Roth IRA for you and your husband, the caution has always been to look at the tax consequences first. You do not want to pay more taxes than necessary.

      When you are looking for someone to help you (which I strongly urge) with the financial and tax planning aspects of everything in your post, you want someone who is also knowledgeable about the tax laws related to rental activity and the IRA rules. This is because there are rules that need to be followed in both areas as well as tax advantages to truly following these rules. More analysis is needed of the facts you have presented that prevent me from providing the right options for you to consider. The right professional will be able to assist you and provide you with the positive tax benefits of following those rules.

      Good luck with the new addition to your family and I hope you find the information helpful. If you have another question, please feel free to post another comment.

  56. My mom passed away on Christmas Day 2011 at the age of 87 leaving her Roth IRA to my 2 sisters(ages 49 and 57) and I (61) equally. It is worth $40,000, can we just take it lump sum without huge tax penalties? There are some small annuities left to the three of us also, it is such a small amount we would rather not hire a tax account, we just want to cash it all in and pay off bills. Thanks!

    • Beverly

      Thanks for your question and condolences to you and your sisters on your Mom’s passing.

      You have indicated that this is a Roth IRA, which suggests that your mother may have done a conversion sometime in the past or contributed to a Roth IRA because she was working and made the contribution. I mention this because the rules are different for the Roth IRA versus the IRA. So be sure that this is a Roth IRA, the trustee will be able to assist you with this question.

      Now for the good news for you and your sisters. As a Roth IRA, the money in this Roth IRA is not taxable to you and your sisters. So you can do what you want with respect to taking some or all of the amount in this Roth IRA and not have taxes owed. You will need to take at least a minimum amount out each year (this will be a different amount for each one of you because you are different ages), but there is no requirement to take it all out at any time.

      If you took out the minimum each year, the balance in the account would grow based on what you have it invested in and that growth would not be taxed either.

      If you find that this is an IRA and not a Roth IRA, each of you would need to take that same minimum out each year as you would with if it were a Roth IRA and include the amount you take out in your tax return each year. The minimum amount would be about $547 ($13,333/24.4 years) for you and slightly lower amounts for your younger sisters. See Publication 590 at the http://www.irs.gov web site for Table 1.

      The trustee should be breaking the IRA up into three separate Roth IRAs for each of you and each of you can make separate decisions about what you want to do with this money.

      If you decide to keep the IRA be sure to name a new beneficiary so that any balance can be transferred easily upon your demise.

      With respect to tax issues on the annuities, the holder of the annuities will send you whatever tax documents that may be required. So be sure to include these items in the tax return for the person whose SSN shows on the document. You may also need to file a final tax return for your mother for 2011. I cannot be more definitive on this since there was not enough information provided in your comment. If all she had was social security benefits and the Roth IRA and the annuity as income, it is possible that no return is needed. A tax professional would be able to answer the question once all tax documents are reviewed.

      • Thanks so much for the prompt reply, this gives us some reassurance and a good starting point! It turns out they are 3 Roth IRA totaling $40000, Mom’s house did have to go to probate since it was only in her name. We are going to take all the documents/info to her regular tax professional. Thanks again for the help!

      • Beverly

        I am glad to get your followup and to see that you will be meeting with a tax professional to help you with your issues. While the issues may seem straight forward at the time, I can tell you from experience I much prefer to have a client come to me at the front end so I can make the process easier than having to deal with unraveling things that the client created that may be unnecessary.

        Enjoy the legacy your mother left you as well as appreciate the value that legacy has for the rest of her family when you preserve it for all who were impacted by her.

  57. I came across this site accidentally tonite and I think you may be an answer to prayer. I inherited a small IRA from a deceased Aunt..around 30,000. I began receiving a RMD last year of 1600 adjusted this year to 1200 plus or minus. My husband is on disability social security after a ruptured heart during a cardiac procedure which caused cardiac tamponade and pleural effusion & other serious medical problems and his doctors declared him totally disabled. Just before this happened, I, his wife, was diagnosed with breast cancer, had a first surgery, immediately followed by a second as it had spread to the lymph nodes, and began chemo and was so sick when my husband’s catastrophe happened. Because he nearly died, fortunately, he required a lot of care upon returning home and I quit my chemo to take care of him and because it was making me so very sick after about 12 weeks and then discovering the first surgeon had not taken out the core needle biopsy site and the cancer was still very much present & growing. a second surgery removed both breasts to keep from having more chemo and radiation only to find that i also had kidney cancer (a different kind of cancer) & had surgery for that 4 weeks after the breast cancer surgeries, and now have an ulcer in my mouth which has not healed in over a year from the chemo sores (had esopageal and throat sores after every treatment…can’t do a biopsy on it because I am also on blood thinners due to deep vein thrombosis. It’d just make a larger hole and give bacteria a chance to get into the jaw line. I also have rapidly deterioration of my bones especially in the jawl joints at my ears from the chemo. I am on comfort care now.. I’m healed til i die sort of attitude. My husband and I both lost our jobs due to these freak circumstances. He has disability social security income and i have the minimal RMD mentioned above because I was told I couldn’t get the IRA out for 5 years when i inherited it. No idea why. That’s our only income now. Because of our short term circumstances, I’d like to remove the IRA’s (his is 12,000 in a CD to mature the end of next year at 3.70 % interest. Mine is an inherited IRA with Merrill Lynch which goes up and down and I know NOTHING about investments and frankly don’t care about them and there’s no reason to believe that we are going to live to even 70 (we are 64 and 60 respectively now. Doctors are amazed we’re still here even at this point. I’d like to withdraw my aunt’s and close the account…but am told that i can’t do that because my husband would lose his SSDI because of a limit by IRS for income? We just see no reason to sit with little income struggling when we could maybe get out and go a bit for a little recreation while we still can. We realize a miracle could happen and we’d live longer…but the odds are very much against that happening. Our children want us to use it to do things now and not leave it behind. We have no debt….we own our house and our older vehicles. However, we dropped our medical insurance because it went up to 1068 a month (carried thru our work thru COBRA until we could no longer afford it because my husband’s SSDI was only 1086. The monthly premium jumped from 357 to the 1068 over a 6 month time span. With utilities, property taxes, insurance, food, family doctor bills, medical tests and medications….there is no way we can afford even half that amount for insurance and with the high deductibles insurance have…it seems senseless to even carry it at all. We don’t qualify for any help because of these IRA’s….So our life is a mess…how can we withdraw or close the accounts and get medical insurance we could afford without a huge deductible which makes it impossible and improbable to think about? (My husband has VA and will soon qualify for Medicare and medical thru SS which means he’s going to be ok….I missed being able to collect social security by about 4 months because I had been a homemaker and didn’t work enough to collect my 40 points required by SS. I was told I needed only 2 to 4 points…but can’t get well enough to find a job to get there….. Which means I have no insurance either. Such a mess we’re in….and tho I’m ok with just “comfort” care….it is because I don’t want to rack up bills and leave my husband with a bunch of bills to deal with….for sure. We have life insurance 25,ooo which would take care of things when that comes…as long as we can continue to pay that premium (that’s important to us) Any advice for us? Thank you so much for your expertise and for having a site where people can get some advice freely. May God bless your business abundantly for reaching out to help those who find themselves in a mess because we didn’t plan for the worst & don’t have the money to pay you what you’re truly worth! I look forward to hearing from you in the near future. Thanks from the bottom of our hearts! Hope to meet you in person some day in heaven! Sincerely…..

    • Debbie

      Thanks for your questions and I do hope you and your husband will be helped with the following thoughts. You are in my prayers to get well.

      As for the IRAs, both of you can access them should you desire to do so. The RMD rules only require a minimum to be taken out but you can take the entire amount out at any time. Since the amount you take out will be taxable income, I would suggest you meet with a tax professional to help you understand how much you can take out in one year and not create a tax bill for you. I cannot do this since there is not sufficient information in your comments to do so.

      On the issue of Social Security benefits, when you reach age 62 you will be entitled to a benefit based on your husband’s work record even if you are not eligible for a benefit under your work record. However, I would suggest, if you have not done so already, that you talk with the people at Social Security to determine if you have some coverage under the disability part of this program. The rules are different for disability than for retirement benefits.

      Given your health situations, I would doubt that either of you would qualify for health insurance coverage other than a government program at this point. While Medicare will cover each of you when you become 65 years of age, the state Medicaid program might provide some coverage for you in the interim.

      You might want to look for a lawyer who specializes in disability and social security issues to get an opinion. In some cases, the lawyer may be paid from the benefits that you would receive if you qualify so your up font cost may be small to find out what you can receive in benefits. This step should be after you check with the Social Security office to see what they say about benefits for you.

      I hope this is helpful and wish you success in your pursuits. Feel free to leave another comment if you have more questions.

  58. Pingback: Rollover IRA Rules – What To Watch Out For

  59. Great blog. It’s difficult to get coherant information when dealing with the various types of institutions. I have a specific question related to a retirement fund. My father in law had a retirement fund where his wife was named the primary beneficiary and my wife and her brother are named the contingent beneficiaries. The intent was for this retirement fund to go to his daughter and son. There is approx. 200K. He passed away in August, then his wife passed away in November (both 2011). Because of his wife’s illness nothing was done upon his death. Left alone this retirement account will transfer to her estate. It is the desire of all parties involved for this retirement account to go to his son and daughter. As opposed to letting it fall into her estate (making it subject to Indiana Inheritance tax) and then giving to his son and daughter, we were told that his wife’s estate could send a letter to the company where the retirement fund exist disclaiming the fund. This would cause it to fall to the secondary beneficiaries (his son & daughter). My question is how this would affect the two estates (which one would it be reported in and taxed) in probate and the Indiana Inheritance Return. I’m thinking this would be a better way of handling this retirement fund and passing down to his son and daughter, than letting it go into his wife’s estate and then making a transfer to his son and daughter. God Bless.

    • John

      Sorry to hear about the passing of both parents of your wife, my condolences to everyone. I apologize for maybe not being of much help in this case as I am not familiar with the Indiana inheritance laws, I think this requires you to contact a lawyer who deals with estates and trusts to get the best answer to the issues you are presenting.

      On a more global basis there are a few things to look into beyond the question of the disclaimer option. First is to be sure that any RMD that may have been required for her father was taken care of in 2011(if he was over age 70 1/2 in 2011 an RMD would be required before any transferring of the remaining balance to any heir). This needs to be done to keep everything correct. Now if he was under age 70 1/2, no RMD is needed.

      You are looking at a tax return for her father and mother through the date of death in November and then estate returns for each of them for the period from date of death in August through July 2012 for the father and from November 2011 to October 2012 for the mother. I would suggest you get a professional tax preparer like an Enrolled Agent (EA) to assist with this to be sure that all required returns are handled properly – go to http://www.naea.org to find an EA in your area.

      The disclaimer is an appropriate way to move assets to another person, the problem is an estate is not a “person” for these purposes, which is why a lawyer is needed to figure out the state laws that will apply.

      While the period of time between the two deaths was very short and there would be a question about whether his wife would have been competent to make a decision of disclaimer (I do not have enough facts to answer this issue) in the time frame you identified, it does point out the need for these type of issues to be dealt with sooner rather than later if what you propose is what all parties would have wanted. This is a comment for others who may read this comment rather than to you.

      Once the retirement fund issues are resolved as to who are the inherited parties (I will assume that it will be your wife and her brother in equal shares), several things to keep in mind. First, be sure that new beneficiaries are named on each account by the new owners. Second, RMDs will be required by each beneficiary from their respective accounts based on their age at time of withdrawal each year – see the IRS publication 590, page 86. This will have to be done every year until their passing. They can take out more than the RMD in any year but not less than the calculated RMD amount. This will be taxable income to each beneficiary to be added to their tax return.

      While you did not mention the other assets in each estate (they each have their own estate to be probated), these other assets may also need to be addressed by what is in each person’s will or trusts. So you need to add this to the list of things to discuss with the attorney.

      I hope these ideas are helpful, even though I did not specifically deal with your disclaimer question. If you have other questions, feel free to leave another comment.

  60. Thanks for the thoughtful answers to the questions that have been posted… here is another scenario that needs some of your input…..
    My mother who was 83 y/o recently passed away. I am the sole beneficiary for her tax sheltered investment in the form of an IRA and 403B. In my Mom’s will she asked that monies be distributed from this particular portfolio to a number of individuals and charities. The total bequeathed to this “group” is $230K. At the time of the writing of the will in 2005 the portfolio had a value of approx $1.2M. After 7 years of RMDs, a downturn in the market and transfer of a portion of the funds to several other IRAs and annuity accounts the portfolio is now valued at approx $650K. The estate is in probate in Michigan and I live in Oregon.

    So here are my questions-
    #1 can I disclaim a portion of the portfolio and assign it to the charities and individuals and #2 assign a portion to the estate ( to cover funeral costs, mortgages, outstanding debts, lawyer/probate costs)? What are the tax implications for me by doing this?

    #3- Can I disclaim all of one of the annuities ( 19K)?- there is no contingent beneficiary- would the money then go to her estate? and if so what are the tax implications? Again the goal would be to cover the expenses of the estate which are about $4k per month.

    #4- My son ( 5 y/o) and my aunt are named as the contingent beneficiaries on another IRA. Can I disclaim a portion of the IRA? my aunt is willing to disclaim her portion which would leave the bulk of the IRA to my son- is this possible and if so can the money be rolled into a 529 educational fund for my son?

    My intentions in all of this is to honor the will even though in reality the fund is a non- probatable asset and I am the sole beneficiary. One thought I had was to disclaim a portion of the fund to cover the named individuals in the will then roll over the balance ( after the required RMD) …….then over the next 6-7 years pay out the monies to the charities as donations from me- this strategy would preserve the earning power of the portfolio while decreasing my yearly tax liability on the RMD.

    Lastly – are these rules for distribution, disclaiming etc IRS rules or specific to a particular “vendor”- I ask because I seem to get a different set of rules from each of the brokerage firms that hold these accounts.

    Lots of questions- hope you can help.

    Frances

    • Frances

      Thanks for your thoughtful questions. I apologize for being so long in responding but I have had computer problems in trying to respond lately but finally got them fixed. So let me see how I can be of help.

      First of all, since you are not in Michigan, I trust you have retained legal counsel to assist with the probating of the estate as well as deal with some of the issues in your comments.

      Next, the disclaimer rules are applicable to all IRAs and have nothing to do with the “vendor”. The disclaimer rules are very specific and need to be followed to the letter to accomplish the things you want to do.

      Any asset that has a beneficiary identified is going to go to that named beneficiary regardless of what the will says. If there is a beneficiary who wishes to disclaim, there has to be a contingent beneficiary also named on that asset in order to accomplish the disclaimer. Any disclaimer needs to be in writing and cannot be changed once executed, so be very careful about doing this.

      On the issue of the annuity, you need to see what portion of it is taxable and what portion is not taxable. There may be very little taxable exposure in the annuity.

      I would be very careful in deciding to disclaim this money to a 5 year-old child. While there would need to be a custodian for this while the child is not an adult, the money is under his control when he reaches adult age. No one knows how this child will handle money when he reaches age 18 or 20. You received a legacy from your mother and you should do all you can to protect this legacy. Here would be my thoughts at this time.

      Keep the money in your name and your sister’s name and remember to name a new beneficiary on each IRA. That could be your son in both cases. You (and your sister) can take the minimum distributions each year as required, make the donations to the charities of your choice (yes, they could be in honor of your mother and to the charities she desired) so you can get the tax deduction for the charitable contribution (saving the tax cost on the minimum distribution).

      While the will may identify a group of people to receive a portion of her assets, they could only get the IRA type assets if they are listed as contingent beneficiaries on the IRAs. If you desire to give them gifts from your portion, be sure to remember that any gift of more than $13,000 per year to each person ($26,000 if you are married and your husband agrees) will eat into your lifetime gift exclusion. So you can meet your mother’s wishes but to do it all at once has consequences. Be sure you know the consequences before you act!

      If you are employed, you may want to use some of the minimum distribution each year to fund a Roth IRA for you (and your husband if you desire to) if you are not currently using this retirement vehicle yourself. Roth IRAs grow tax deferred like the 401k/403b does but it does not require distribution in your lifetime like a 401k/403b will at age 70 1/2 and, most importantly, the growth or income is not taxable in the Roth IRA when you do take money out. Contributions to Roth IRAs are limited to $5,000 ($6,000 if over age 50) as long as your earned income is more than that.

      You mention “rolling over” this money. Inherited IRAs can not have their character changed, they are an inherited IRA as long as money is there. You options are take minimum (or more) distributions each year or disclaim if there are contingent beneficiaries named on the IRAs.

      With respect to establishing a 529 plan for your son, I am not particularly enamored with putting money into an educational savings program for several reasons. Your son may not need this money for college, you won’t know this until he reaches college age. Money in an educational fund must be used for that purpose or it is taxed and penalized when used for non-education purposes. My preference is for you to fund your retirement (you know you are going to do this!) by using the Roth IRA. Contributions to the Roth can be taken out at any time (like pay for college), you just can’t touch the earnings until age 59 1/2. This provides you much greater flexibility over this money than having it tied to education.

      I think I covered all the issues you asked about. My final suggestions are that you go to the top of this page and click on “Find a Planner” to locate a planner in your area who is fee-only to assist you with the financial planning aspects of the above and then go to http://www.naea.org to find a tax professional who is an Enrolled Agent (EA). An EA is someone who specializes in tax preparation and can assist with tax problems with the IRS if that is needed. These two professional will become your best friend in making sure that these issues are addressed to make the most of the legacy you received from your mother.

      Hope this is helpful.

  61. Francis – Do these apply to Roth IRAs? My one minor child and one major child inherited $750 each. If they choose to get a distribution on these what impacts should they be considering? The original Roth was opened in excess of 5 years ago.

    Thanks for your excellent article.

    • Narendra

      The rules related to minimum distributions for IRAs applies to all IRAs including Roth IRAs. The difference between an IRA and a Roth IRA is that the amount taken out of a Roth IRA does not get taxed. Distributions from IRAs are subject to being taxable income unless a portion of the IRA was “basis” which would not be taxable.

      The age of the Roth IRA has no bearing on what you have to do when it is an inherited IRA.

      You have indicated that the value of the Roth IRA is $750. Based on the ages of the two children, their annual minimum distribution would be like $7 or $15 each year. You might want to take out the entire amount at one time. For the adult child (and maybe the minor child), if they have wages of $750 or more, they could use this money to start their own Roth IRA. This new Roth IRA would not require any distributions during their lifetime unless they wanted to take some money out later in life. They are able to contribute up to $5,000 each year assuming they have at least that amount of wages or earned income.

      Hope this helps.

  62. Thank you for such a great site…
    My question is my husband inherited a traditional IRA from his father in 2011, he had started making RMDs and my FIL had taken his 2011 RMDS. The IRA was worth 350,000

    Against my advice my husband decided to withdraw 300,000 of the money and split it in savings accounts between our three children. My husband makes over 100k a year and did not ask for any tax advice prior to doing this..so obviously we are going to get slammed in taxes this year. Since he did this about three weeks ago can we put the money back…the account is still there with approx 50,000 sitting in it. Is there a sixty day limit like there is for our own IRAs?

    Thanks,
    Mary

    • Mary

      You have raised some very important issues that anyone reading this comment and your issues needs to think about when they inherit an IRA.

      The 60 limit to put the money from IRA into another IRA does not apply to an inherited IRA, so I am afraid you cannot do that per the regulations. As such this will become taxable income to you and your husband in the year he took this money out. That is going to be a sizable tax bill as I am sure you have already figured out.

      Anytime someone receives a great deal of money unexpectedly, whether by inheritance or winning some money, the first thing they need to do is to consult a financial and tax expert to get a clear understanding of what the options are to consider. I am not suggesting that you blindly follow the advice you receive, but the professional deals with these type of issues all the time and they will, or should, know what the rules are to protect the assets you are receiving. This will be a very small price to pay as compared to the tax cost for this decision by your husband.

      Now that I have finished my rant, one avenue that your husband could consider is to request a private letter ruling from the IRS to see if they will let him put the money back into the IRA and take the annual minimum distributions that would be be more tax efficient. This process will cost you to make the application to the IRS and I am offering no assurance that they will approve the request to put it back. Should you decide to go in this direction, I would strongly urge that you get an attorney who prepares private letter requests to the IRS and who will have some idea of what the chances are for success. The costs you incur will be the cost of the education to learn how important such advice can be when it is obtained up front rather than after the toothpaste is out of the tube.

      Finally, I hope this money is not just sitting in a savings account earning the paltry rates that savings accounts are paying today. Your FIL left a great legacy and these assets need to be properly invested to grow in the future. A professional planner can assist with this (check out the Find a Planner at the top of this page) both in where to invest as well as to protect the earnings from being taxed by using IRAs and other vehicles.

      Hope this is helpful

  63. I am 74 years old.. I have inherited 46% of an IRA (about 78K). THe check came today.. Since I’m too old to “add to” an IRA, what should I do. Is there any way to avoid the 15% tax?
    My income is approxamately 22K Annual. 1/2 of that is Social Security. There were 8 total beneficiaries to this particular IRA, EVERYONE took the cash, in my case that was manditory. Or at least that what what I was told.
    I want to pay my house off. The payments would use1/4 of my income.
    Reading what the tax consequences are, I’m now puzzled about what to do?
    Any advice would be appreciated…
    Gloria

    • Gloria

      Very good questions. You have several options related to how much you have to take from this IRA. If you use the option to take out based on your life expectancy, you would be taking out about $5,550 the first year and this amount will go up each year. Whether this will create a tax liability is based on what other income you have each year. Based on what you gave as information, I would think you could use the VITA tax preparation service that should be available in your area. It is a free service for people in your income bracket.

      You can take out more than the minimum amount, but I would ask the tax preparer you talk to to help figure out how much you can take out without creating a tax based on your income.

      You have a great idea about paying off the mortgage but consider the tax consequences as well as the savings in interest from the mortgage when deciding to take out more than the minimum from the IRA.

      Also be sure to determine if this IRA has any “basis” in the total IRA as that amount would not be taxable. Your tax preparer can help with this too.

      Hope this helps.

  64. What a great source of information you have here! Wish it was available years ago when I became a recipient of an inherited IRA…my siblings and I had lots of trouble finding reputable information.

    My question is in regard to the current Federal “Retirement Savings Contribution Credit”.

    I take an annual required distribution from my beneficiary IRA account inherited from my father. My husband and I also both contribute aggressively to 401K plans with our employers and file jointly. When calculating eligibility for this “Retirement Savings Contribution Credit”, do we need to reduce our contributions figure by the distribution amount received from the beneficiary IRA?

    I have not been able to find any clear answer to this. Since this is an inherited account, and we did not make the contributions, do the distributions still count against us for this credit? If we just went by our current 401k retirement savings, we would be eligible for this credit.

    Thank you for any insight into this.

    Louise

    • Louise

      Sorry to be so long in answering your question.

      The Savings Credit Is available to those who contribute to IRAs but it does have certain income limitations to getting the credit. The fact that you are taking distributions from an inherited IRA does not limit you getting the credit if you qualify.

      Here is an IRS memo that contains the pertinent issues for you to consider:
      IRS Tax Tip 2012-36, Feb. 23, 2012. You can access this at http://www.irs.gov, where you can find other information related to this great credit.

      If your income is too high, you may not be able to qualify for this credit. In addition to the 401k you contribute to through work, you are also eligible to contribute to either an IRA or a Roth IRA depending on your total Adjusted Gross Income. I would encourage you to look into how to contribute to the Roth IRA as this will be a valuable part of your retirement assets if you use it.

  65. Sir, thank you for this very informative blog. Instead of burdening my sole beneficiary with an RMD at his tax bracket, does it make more sense to substantially increase my RMD and my much lower tax bracket?

    • Mark

      Very good and interesting question,and thanks for the kind comments. Since you did not give me some important facts about the amount of your IRA, your age, the age of your beneficiary, who the beneficiary might name, who else you could be leaving the IRA to, and some other options to do with the IRA, I can only provide some general ideas to consider.

      First, consider how long you still have to live and enjoy life. None of us knows how long we will enjoy life on this earth, but consider that the fastest growing age group are people over 80 and the oldest person today is 115. You probably have many many years to live.

      Second, you could use the conversion of the IRA to a Roth IRA as one way to do several things. If you converted some or all of the IRA to a Roth IRA, you would eliminate the need to take RMDs during your lifetime as well as take the tax issue off the table for your beneficiary. Roth IRAs do not require RMDs during your lifetime and they do not result in tax issues for the beneficiary upon your demise.

      If you were my client, I would be looking at what tax bracket you are in currently and determine how much you can convert each year and stay in that tax bracket. Once you do the conversion, that amount is no longer subject to the RMD rules. So if you converted all of the IRA, you would no longer be required to take RMDs each year. You could still make withdrawals as you need money but are not required to do so.

      One issue to be careful in doing the conversion is that there is a 5 year requirement that starts with the first conversion date before any of that amount can be accessed and not have any penalty apply to the converted amount. If you are sure that you will not need the converted money for 5 years, you could convert 100% now and thus avoid any RMD during your lifetime.

      I would suggest you contact a tax professional (go to http://www.naea.org to find a qualified tax professional (Enrolled Agent) in your area to assist you in how to do this efficiently)

      If you truly have only one person who could receive this legacy, you should discuss this with the intended beneficiary to see who that person might name as beneficiaries when the IRA becomes owned by the beneifciary you have named of the IRA. Knowing this, you might want to name contingent beneficiaries on the IRA. This accomplishes two things. One, it provides the beneficiary the ability to give up (disclaim) their interest in the IRA to the contingent beneficiaries upon your demise for any number of very good reasons. Two, it assures you that should the beneficiary pass away and you have not named a new beneficiary, there are the contingent beneficiaries already named. This will make the probate process go much easier for the executor of your estate.

      Since you have suggested that you have a sole beneficiary for the IRA, that suggests you should be sure that the rest of your estate plan is current and complete. This would include being sure your will is current and meets your desires for all of your assets. There may also be a need for a trust to be considered if you have a large amount of other assets that would be subject to probate if they are not in a trust. This all falls under the purview of meeting with an attorney who specializes in estates and trusts to consider what makes sense under the laws of your state.

      Finally, if the eventual beneficiary of your IRA is not in need of this legacy upon your demise, you could consider naming a charity as the beneficiary or the contingent beneficiary. A charity will not have to pay taxes on the balance in the IRA, so the conversion to the Roth IRA would not be needed at this time. By having that contingent beneficiary(ies) named, this would allow the beneficiary to disclaim the inheritance and thus allow it to pass on to the contingent beneficiaries as you desire.

      I hope this has provided you with some ideas to consider. Enjoy many more years of life!

  66. Jane
    I am so glad that I came across your site. Our family needs your advice. My husband’s grandfather passed away recently and has an IRA worth a little over 12,000 that is to be split between my husband and his two sisters. If the sisters wish to withdraw their portions and my husband wishes to keep his portion in an IRA is that possible? Also, if the total amount is withdrawn and divided equally between all three what penalties/tax consequenses would we face?

    We greatly appreciate any advice you can give us.

    • Jane
      Thanks for your comments. From your posting, it appears that the three siblings were all named as beneficiaries to the IRA. If that is the case, each sibling can have their share moved into an IRA for their individual benefit. Then each one can do as they please with respect to taking out the entire amount or the minimum amount (required by law) or some other amount.
      Since it appears that the grandfather passed away in early 2012, it will be important to be sure that the RMD for the grandfather was taken out in 2012. If that was not done, then that will be required first before the balance can be moved into the inherited IRAs.
      As you may know, the amount withdrawn will be subject to being taxable (unless there is a “basis” in the IRA). So the sisters may want to be sure they want to take it all out in one year. They could take some out this year and then some out next year to spread the tax burden if that would be an issue.
      If your husband wanted to take the RMD each year on his $4,000 share, he would be looking at about $100 to $160 per year that would be the RMD. The balance could continue to be invested and grow going forward. He should understand that no more money can be put into this inherited IRA and it cannot be converted to a Roth IRA. Given the small value of this IRA, he might want to consider taking it all out and then using it to fund a Roth IRA for himself, assuming he is not using the Roth IRA today. He would be adding that to his taxes for this year but the Roth IRA would grow tax free going forward and he would not have any tax on that growth when he takes out the Roth IRA in the future after age 59 ½.
      I hope these comments help. If you have more questions, feel free to leave another comment.

  67. Our mother passed away last month. She has a small IRA and METLife account. Her current husband and she have a non-comingling financial prenup. We are trying to honor her wishes by using her monies to keep the home and provide her husband a lifelong lease. Should we disclaim these monies? Do they go to probate and then just to her estate after settlling those
    affairs? We want the monies to work in the way she intended. We will be the “Landlords” of the home as he has no attachment to any asset of hers. Help we need advice.

    • Rhonda
      Sorry to hear about the passing of your mother, my condolences to you and your family.
      I am not sure I can answer your questions about probate as that is a state level issue. Also, since there is a prenup involved I would suggest you contact the attorney who created the prenup or someone who specializes in probate issues in your state.
      As for the IRA and the Met Life (annuity?) account, the issue is who are the beneficiaries on these two documents and are there any contingent beneficiaries listed on the accounts. If there are contingent beneficiaries, then whoever are the beneficiaries can decide to disclaim if that is their desire.
      Before you do that disclaiming, however, be sure you have looked at what the issues would be if the beneficiaries stayed as the beneficiary and took the RMD each year for the IRA. The Met Life account may need different handling if it is not an IRA (you may have less options if it is an annuity).
      Since the IRA and the Met Life have beneficiaries, they would not normally be part of the probate process unless they do not have named beneficiaries.
      The attorney can also assist with thinking through how you act as the “landlord” during her husband’s remaining years and how the estate gets settled now or after his passing.
      I am sorry I was not able to be more helpful, but there are numerous facts that I am not aware of to speculate on what advice to give you.
      If you have other questions, feel free to leave another comment

  68. Dear Mr. St. Onge,

    Thank you for the very informative blog post. I have learned quite a lot about this complex issue from your article and from the comments as well. My mother passed away last month, leaving about $270,000 in a rollover IRA. She had other assets, but this was by far the largest. My oldest sister and I are the beneficiaries; our other sister was not named as a beneficiary. Her will stated that her assets should be divided 25% to each of her three children, with the remaining 25% divided among her seven grandchildren (all minors). We were considering taking a lump sum and then gifting a portion to the sister who was not a beneficiary, but this would be a significant tax burden on us. I learned about disclaiming an inherited IRA through your post above and was wondering if this might be a better solution. Should we each disclaim a portion? If so, how much? Would we want to disclaim a portion that would go to the grandchildren?

    She was 68, and I am not sure if she took any distributions from the IRA.

    Thanks very much for your help.

    • Cindy

      Sorry to hear about your mother’s passing, my condolences to you and your family.

      There is a provision in the inherited IRA rules for a beneficiary to disclaim her share and allow it to go to a contingent beneficiary. However, if your sister was not named as a contingent beneficiary for any reason, that route is not possible. So we would need to devise another way to get this or some portion of the money to your sister and to the grandchildren.
      Whoever would receive the inherited IRA would be required to take annual minimum distributions over their remaining lifetime. Since your mother was 69 when she passed away, I will assume that you and your sisters are in your mid to late 40s for this discussion. If you were age 45, the minimum distribution the first year for the entire $270,000 would be $6,959. You can take more than that but not less. If all of this were taxable (see below about “basis”), then you and your sister who is a beneficiary would be adding about $3,500 each to your tax returns. If this was taxed at 25%, the tax would be $875 each.

      Each of you can take as much as you want out each year, pay the tax and then gift to anyone you desire up to $13,000 each year and not have to worry about any gift taxes on that amount. Anyone receiving the gift would have no tax implications for them.

      One thing you need to check on is what was the source of this IRA from the contribution side. By that I mean was this from money your mother contributed to an employer plan at work or was it from an IRA that your mother contributed to on an after tax basis. If this was an employer based program, then all of this will be taxable as it is taken out. If it was an after tax IRA, the amount she contributed each year would be considered “basis” and that amount would not be taxed on each year’s withdrawal thus lowering the tax burden on each withdrawal.

      Now to deal with what you would like to do to meet your mother’s implied wishes of dividing things into 4 pots. Each pot would be worth $67,500. For you and the sister who are named beneficiaries, the minimum distribution the first year would be $1,740 that would be added to each tax return and be the tax liability of you and your sister. The part that you want to go to your sister who was not named as a beneficiary would also be worth $1,740 and the part that would go to the 7 grandchildren would also be worth $1,740. The total tax for all 4 parts would be the $875 noted above, or a total of $1,750 for you and your sister combined – no difference in tax just being spread between everyone.

      If I net things out, the net amount you want to go to the sister not named is $1,305 ($1,740 – $435 of tax) and the net amount to each grandchild is $187 ($250 – $63 of tax). These amounts are all below the gift tax threshold so this is not an issue.

      The above is for the first year of distribution, the amounts will change each year as the divisor will change each year. For a person age 45, the divisor in year one is 38.8 years. In the second year, the divisor goes down by one to 37.8 years and the same reduction of one is made each year going forward for a total of 38.8 years. You need to look up Single Life Expectancy RMD Table (for Inherited IRAs) in the IRS Pub 590 which has all the rules related to this issue. I am assuming that you and your sister who is a beneficiary are not the same age so you will each have a different divisor based on this table.

      Since your mother left all of you a legacy I am assuming for the above that you want to keep this legacy in her name for all the people you are trying to share with. As such, I have not suggested trying to move this money to them directly but rather to keep the legacy under the control of you and your other sister who was named. That is not the only option open to you, but it does assure you that the legacy continues into the future.

      As such, it would be important for you and your named sister to be sure to set up new beneficiaries and contingent beneficiaries on each of the inherited IRAs. You have seen what happens with not having the contingent beneficiaries on your mother’s IRA, so you need to plan accordingly.

      Now if the plan I have suggested is not what you want to do going forward, you can certainly take out more the minimum amount each year. You just need to recognize the tax consequences related to the additional amount being withdrawn. When I am working with a client who has an inherited IRA, I will look at what is the most they can take out and stay in the tax bracket they are currently in. For instance, I used the 25% tax bracket in the example above. Let’s assume that either you or the other sister who has inherited the IRA is in the 15% tax bracket and perhaps there is $10,000 between your current taxable income and the top of the 15% bracket. You could then take out the additional $10,000 (tax would be $1,500) and you would have $8,500 that could be distributed to the others you want to get this money to in honor of your mother.

      That same $10,000 withdrawal could be done by you from your portion and you could use the proceeds to help fund a Roth IRA for you and your husband (assuming you are married and not currently contributing to a Roth IRA). What this has effectively done is allowed you to pay 15% tax today on the $10,000 and allow the future earnings of the Roth IRA to not be taxed in the future assuming you would abide by the Roth IRA rules. By the time you are the age of your mother, that $10,000 would grow to $40,000 if it was invested and earned 7% annually for the next 20 years. That $30,000 growth would be tax free in a Roth IRA. If that increase occurred in the IRA, that same amount would be taxed when you took it out.

      What these ideas suggest is that you may need the assistance of qualified professionals to assist you with developing the right plan for you and your family so the legacy of your mother can live on for many years and grow. If you go to the top of this blog you will find a place to “Find a Planner” which will get you to a qualified financial planner in your area to help with the planning and investment side of these issues. You can also go to http://www.naea.org to find an Enrolled Agent who can provide the tax expertise related to how the income from the IRA and Roth IRA will be treated.

      I hope I have answered your concerns. If you have further questions feel free to leave another comment.

  69. Excellent blog. I have an interesting situation involving a court case where there were two opposing wills for my Father’s estate. All assets were placed under court mandated injunction preventing any modification of funds or assets until the case was resolved. The case has recently settled. I am a beneficiary of a traditional IRA, valued at < 50k. I would like to disclaim, but the nine month window has passed due to the year long court situation. Options? Thanks in advance.

    • T Brent

      Thanks for your kind comment about my blog, I am glad you have found it helpful. You have raised some important issues about inherited IRAs, so let me try to address them for you.

      The first issue relates to your desire to disclaim your share of the IRA. This requires that the person(s) you desire to get this IRA are named as contingent beneficiaries on the IRA . If they are named, then you can disclaim and they would be required to take annual distributions just like you are. The difference would be they would be taking an amount based on their age rather than your age. This would change the annual amount required to be taken out and would also change the tax consequences as the amount would be taxed at their incremental tax rate which might be lower than your tax rate. All these changes would allow the IRA to last a longer time into the future if the persons you desire to receive this IRA are younger than you.

      While the IRS rules are not clear on the next issue you raise, I believe you could make an argument that the nine month window you reference does not start until the date of the court decision that held up who were the correct heirs. To resolve this completely up front would require you to get a private letter ruling from the IRS. This is an expensive process and I am not suggesting this as the best route to go because of the cost of the ruling ($10,000 application fee for starters). So we need to look for a different answer for you.

      As you probably know, you are required to make a minimum withdrawal but you can take more than that in any year that you so desire. So, you could keep the IRA and make a withdrawal, pay the taxes, and then make a gift to the same people you were thinking of disclaiming to so they get the benefit in the same way that they would if you were able to disclaim. You could even agree with them that you will take out the amount they would be taking out if they had the IRA. Consider the extra tax you might pay as part of the cost of getting the private ruling from the IRS.

      Another avenue you might want to consider is to look at taking withdrawals from the inherited IRA for the purpose of contributing to a Roth IRA for you and/or the persons you desire to receive the inherited IRA. You would still owe taxes on the withdrawn amount but you would be eliminating taxes on the future growth that will occur in the Roth IRA. That same future growth in the inherited IRA would end up being taxed as you/others would take the minimum withdrawals from the inherited IRA. Once in the Roth IRA, you would then be able to reap the many benefits of the Roth IRA.

      As you can see, these ideas are getting a little complicated, which suggests that you should review these ideas with your financial planner and/or tax preparer who can bring all these ideas together and make sure no options are being missed. A CFP fee-only planner can be found at the top of this blog “Find a Planner” and a qualified tax preparer (Enrolled Agent) can be found at http://www.naea.org.

      And finally, don’t forget to name a new beneficiary and contingent beneficiaries on this inherited IRA so that future decisions can be made as needed.

      I hope these ideas meet your needs. If you have more comments, feel free to leave another comment.

  70. Dear Mr. St. Onge,
    My Mom passed away Dec. 6, 2011. We thought she had a “cut and dry” will, however it’s not the case. There are 3 daughters that her intent was to divide everything equally among the 3 of us. A portion had just been put into an annuity last July, but Lincoln Financial was willing to return the money to the 3 of us, which they did. My Mom also has a traditional IRA with approx. $170,000 with only myself listed as a beneficiary. The Financial Institution, 1st Tenn. Bank has not been “beneficiary friendly” to work with. As far as I know there is no contingent beneficiary listed. My Mom was 84 and was taking her yearly distributions. We have been told that the agreement/contract on the IRA holds precedent over the will. One sister is getting ready to begin drawing from her IRA in the spring, one sister is currently not working, and I have a full time job. I have had a couple of suggestions, one is to set up a beneficiary account and take the distributions yearly, and divide it with my sisters, or gift it, however you want to word it. My concern is that it will move me into another tax bracket which will affect my entire income. Another suggestion was for me to take my portion and disclaim the other two-thirds of the money. Will the two-thirds go to the estate? and then on to my 2 sisters equally? By the way, we did not probate the will, as it was not deemed necessary by the Estate Attorney. Another “hiccup” in the scenario is that I work for a large financial institution and I have to move my share to my bank or 1 other approved financial institution that handles our retirement accounts, 401K & Pension plan. I asked for an exception regarding moving the funds, but was denied.
    The Estate attorney suggested that if we leave the funds in my name, which will have to be moved due to my employer’s restrictions, that we draw up some sort of agreement/contracts to protect everyone’s interest and include contingent beneficiaries on that as well. I am turning 60 in a couple of weeks, and I’m the youngest of the 3. I believe the span of taking the RMD is 20+ years, however we had already discussed taking more. I am afraid that if I leave the entire IRA in my name and I take the distributions, that it will be an accounting nightmare as well the tax liability ending up in my lap! Do you have any other suggestions? The Estate Attorney says to talk to our CPA, the CPA says to talk to the Estate Attorney. The funds are in Tenn., as are my 2 sisters. I am in Florida, and that’s where the funds will have to be moved. If I’m disclaiming the two-thirds, I have to do this before Sept. 1, is that correct?
    A prompt response will be greatly appreciated as I am going to TN. to take care of this next week. Thank you so much for your time and knowledge!
    Anne

    • Sorry to hear of your mother’s passing as well as the challenges you are facing. There are quite a few issues you have identified, some of which I am not going to be able to help with. But let me try to be of assistance.

      The IRA rules on disclaiming require that there be named contingent beneficiaries in order for you to disclaim and let the contingent beneficiaries be the recipients of the IRA. That does not appear to be the case here. Based on the information you provided, the minimum distribution the first year would be about $6,700 which would be taxed at your incremental tax rate (I am assuming that would be either 15% or 25% for this response). So your additional tax would be about $1,000 to $1,700 giving you a net of $5,000 to $5,700 that could be shared between the three of you if you so desired. The yearly amount will go up each year that you need to take out as you get older.

      You have the ability to do a trustee to trustee transfer of this IRA at any time if you are not happy with the way the bank is dealing with the issues you have. So I would find the trustee you desire to use and have them handle the paper work to do this transfer – under no circumstances do you want the current bank to issue you a check in your name as that has disastrous tax consequences for you. A trustee can be a mutual fund company or some other financial institution of your choice. I do not understand what the restriction is that you are referring to as it relates to your employer so I am not sure how to help here. You should be able to have money invested wherever you want and this money should not (cannot) be commingled with any 401k or pension plan associated with your employer. This IRA will be titled “Beneficiary IRA for Anne” for as long as you have this IRA.

      While you are required to take a minimum distribution each year, there is no limit as to how much more than the minimum you take. So, you could take a minimum for several years until you retire and then increase the amount when you may be in a lower tax bracket. This requires more financial planning than I could do with the information available, but I would encourage you to engage a fee-only financial planner with a tax preparer focus to assist you with this aspect. You can find one in your area by going to the top of this blog “Find a Planner” and putting in your zip code.

      As for tax assistance, I would go to http://www.naea.org to enter your zip code to find an Enrolled Agent who is someone who specializes in tax preparation and can assist with the best way to figure out a long term tax plan that will take your facts into consideration.

      There is also a five year window available where you could not take any distribution each year but then by the end of the fifth year you would have to take the entire amount in one withdrawal. I am not sure this option would be of benefit but again that requires someone to look at your specifics in much greater detail to map out the right plan for you.

      As you assess the entire situation, keep in mind that the IRA will be taxed at some amount regardless of who is receiving the money over the next 25 years or so if minimum distributions are taken each year by you or by someone else. Yes, it is wise to try to minimize the tax burden but do not let this drive the decisions that need to be made over many years. Your mother left a great legacy for you and your siblings to enjoy and enhance, and I am sure you desire you also leave a legacy going forward. Be sure to name a new set of beneficiaries and do not forget to name contingent beneficiaries for this IRA as well as your 401k and IRAs.

      If you do share the withdrawal with your siblings, be sure to understand the gift tax rules as they may impact how you decide to move forward. These rules allow under current law for you to gift to others at the rate of $13,000 per year to each and every person you desire to do so without any tax consequences.

      In case you do not need any of this money to meet current lifestyle needs, I would also suggest that you consider contributing to the Roth IRA retirement program if you are not already doing so and you have earned income each year. This is a great way to add to your retirement funds and not create taxable income later in life.

      I am not familiar with the Tennessee or Florida tax laws and am not an attorney so I am not able to help with the estate laws or the probate rules. I hope I have helped some with the challenges you face, I am sure the suggestions I made to get a financial planner or a tax professional to assist you will be helpful as they can look at actual documents and talk to the banks or your employer on your behalf to figure out what will work best for you and your sisters.

  71. Thank you for your blog…it has been helpful. My father-in-law passed away in September of 2012 at the age of 58. He had a traditional IRA in the amount of $82,000 and left my husband as the beneficiary and he wasn’t taking any RMD at the time of his death. My father-in-law had a will, but it states that all accounts that have a beneficiary are to go to that beneficiary (my husband in all cases). My father-in-law told my husband and his brother that he wanted the money split equally amongst them, however, he didn’t leave the brother as a beneficiary on this IRA account. My thoughts on this are to take the other liquid money and basically ‘buy’ his brother’s portion of the IRA so we can leave the IRA to grow. (His brother wants the money now and has no interest in letting the money grow.) What are our options here? How will the IRA work after we roll it over into a beneificiary IRA? Our banker told us that we wouldn’t have to take a distribution each year because his dad wasn’t 70 and a half at the time of his death. She said we could put it into an IRA for a timeframe of 3 months up to 5 years, but I keep reading all of this conflicting information. Will we have to take yearly distributions for the life expectancy of my husband? Will we have 5 years to get all of that money out? Will the money have to stay in the IRA until my husband is 59 and a half before we can take it without penalty or does that not apply in this situation? Sorry if these are repeat questions. Also some other info that might be helpful….my husband is 32. His dad’s IRA matures on May 11, 2013 and is currently earning 2.96%. What do you suggest?

    • Ashley
      Thanks for your comments on my blog and my condolences on the loss of your father-in-law. He passed much too early from this life.

      You have raised many great questions about the inherited IRA and you have certainly received confusing information from several sources. Let me try to create a reasonable course of action for you and your husband.

      The beneficiary designation on the IRA is the controlling document with respect to who receives the IRA. The will cannot overrule that designation. Your husband now has an inherited IRA and those rules will govern what can be done. There are basically two options (there are more but two will suffice for now): 1) your husband can take minimum distributions from the Inherited IRA based on his life expectancy or 2) take all of it at any time.

      If minimum distributions are taken it would be based on your husband’s age (32) and the first year factor would be 51.4 divided into the $82,000, or $1,605 the first year. The factor changes each year based on Table I of IRS Publication 590. The second year the factor is 50.4 divided into the balance at the end of the previous year so each year more will be taken out. The amount withdrawn will be taxable income to your husband each year. The factor gets smaller each year as your husband gets older.

      Beyond the minimum your husband can take out as much as he wants in any year but he must take out the minimum for sure. If he is looking at letting this IRA grow over time to be part of his retirement program I would suggest he just take out the minimum each year.

      With respect to following his father’s wishes of sharing half with his brother, we have a few other considerations to look at. First would be whether this sharing idea is written into the will or whether it was a discussion between the three of them. If it was written into the will we then need to look into what other assets are available to be shared. As long as the two brothers are in agreement with what they want to do, then they can split the total in half and then decide which actual asset each one gets.

      However, if the major asset is the IRA and that is what we are trying to divide I think you have a few other issues to be aware of. The first might be what is the real value of the $82,000 IRA. That may be the total value but it has a tax liability included in it so the net real value is something less. If the incremental tax bracket for you and your husband is 25% then there is a tax liability of $20,500 leaving a net cash of $61,500 that I would argue is the true amount to be shared. Assuming that was agreed to, then if your husband gave $30,750 to his brother that would be a gift and would be subject to the gift tax rules. The current annual gift amount limit is $13,000 per person ($26,000 if you agree to gift as well), so that would leave $4,750 that would exceed the limit for 2012. I would suggest that your husband gift $26,000 this year and the remaining amount be gifted on January 2, 2013, to avoid any further issues related to the gift rules.

      On the issue of the IRA maturing in May 2013 and earning 2.96% currently, I would suggest you discuss with the bank what penalties would exist if this were cashed in now in case you wanted to move it somewhere else. If there was a penalty of any significance you might want to leave it there until next May. Going forward your husband should be looking at this IRA under how this fits into his goals and objectives for retirement money. I am suggesting that his investment goals and objectives will be or should be different than what his father’s goals were since he is a generation younger than his father and he has a long life of growth ahead of him. This $82,000 would grow to about $1.3 Million at a 7% annual return before we consider the impact of the minimum withdrawals each year. As you can see that is a substantial amount which is suggesting that the $82,000 is a great legacy to have received from his father. These amounts do not take into account the minimum distributions that would reduce the value over time or the tax impacts, so that needs to be considered in your thinking.

      Another consideration when looking at how much you may want to take out of the IRA in any one year is the incremental tax bracket you are in when you add the amount you are taking out in a year. It is possible that you could put yourself in a higher tax bracket for some of the withdrawal that could create a tax burden unnecessarily. So I would suggest you talk to your tax professional about the tax impact on whatever you are planning to do before you do it. If you do not have a tax professional you can go to http://www.naea.org to find a tax professional in your area who is an Enrolled Agent to assist you.

      While the inherited IRA will be named for the benefit of your husband, it will be important for him to name a primary beneificary(ies) and I would suggest that he name a contingent beneficiary(ies) as well. If his father had named both sons or at least named the second son as a contingent beneficiary, I would have some different thoughts on what the solution would be today.

      Finally, I would suggest that you go to the top of this blog to “find a planner” and look for a financial planner in your area to assist you with some of the intricacies of how to look at what this legacy does to the financial plans for you and your husband. This legacy is a big boost to the growth of your financial wealth that should have some impact on how you save and invest for the future. The time to get a financial planner involved is at the beginning of the process to be sure you have addressed issues that a planner will be aware of that you may not have thought about on your own.

      I hope this has helped you understand the issues facing you and your husband. If you have more questions please feel free to leave another comment.

  72. Mr. St. Onge,

    Thank you for writing this article. It is very informative. Like the other readers I have come to receive an IRA inheritance. However, my situation is slightly different from the others and I am at a loss on how to handle my situation.

    My dad passed away in 2005, at 43 years old. I was 21 at the time. In January 2011, I received a notification from his brokerage account that I am part beneficiary of his Traditional IRA. As such I opened an Inherited IRA account to hold my portion worth 8300.00 at the time. Being unfamiliar with the dealings with an inherited IRA, I asked the brokerage account if I need to take money out. They said that I didn’t have to take the whole thing out until 5 years after I open the account.

    I started to doubt that advice when I stumbled upon more literature regarding RMD’s for Inherited IRA. So I went to a couple of tax advisors. One recommended taking the whole fund out of the Inherited IRA. The other recommended taking distributions starting when I opened my account. If I choose to take distribution, should I have started for 2011 or should I have taken it from 2006? I don’t even know how much the account is worth from 2005-10 since it was still in his name. If I take the whole fund out, will I have to pay the 50% excise tax on the whole thing or just to the RMD’s I should have taken?

    Thanks,

    Mnemo

    • Mnemo

      Thanks for your comment. There are some facts that are not available from your comment to be able to give you a firm answer to your questions but let me give you a few things to consider.

      The rules related to inherited IRAs give two basic options for the beneficiary. One option is to take minimum distributions (RMD) each year and the second option is to use the five year rule that requires the entire amount to be taken in a lump sum.

      One of the issues you are faced with is when did you learn of the inheritance. From what you wrote it appears that you did not learn about this until January 2011 which you could use as the start of this inherited IRA. You did not indicate what was happening between 2005 and 2011 as to why you were not aware of this IRA, so that might impact the issue of the start date and the actions you can take.

      So let’s look at the amounts you have inherited. If the value was $8,300, the minimum distribution each year is based on your age of 26/27 today. The factor for the first year is 57.2 for a 27 year old. This factor goes down by about 1 each year so at age 28 it is 56.2 and so forth. This gives an amount of about $145 as the minimum. You can take any amount above that each year.

      You could also take the entire amount out and close the inherited IRA account out. In either event the amount withdrawn would be taxable income to you unless there was a cost basis in the IRA. This means you need to pursue with the executor of your father’s estate or the broker who was handling the IRA to determine how this IRA was created.

      If the IRA was from a work related 401k type program the entire amount would taxable because there would be no cost basis. If however, the IRA was from contributions that your father was making to the IRA outside of his work then there may be some cost basis. If there is cost basis then some amount of what you received will not be taxable. So you have some work to do investigating these issues.

      Assuming that the entire amount is taxable, than the amount you take out will be added to your income in the year you take the money out. You are probably in the lowest tax bracket that you will be in for the rest of your working life, so now would be a good time to take this money out and pay what tax is required if you want to close out the account. If you do not need this money to meet every day expenses and you want to preserve the legacy your father left you, I would encourage putting this money into a Roth IRA for your retirement. You can put $5,000 in for 2012 and $5,000 in for 2013, assuming your income is below the limits of $110,000 if single and $173,000 if married.

      As for the 50% penalty issue, you can work on correcting for that by taking action as soon as you know you have a problem (2012) and pay the tax on what you withdraw. Taking the most conservative approach, you take out the RMD from 2006 to 2012 of about $900 ($150 x 6) in 2012 and include that in your 2012 tax return. You would include Form 5329 in your tax return and request a waiver of the 50% penalty with an explanation of why you should not be penalized. Once the IRS reviews your tax return and makes their decision, you can appeal their decision if you do not like the result.

      Your explanation should indicate that you did not receive the notice of your inheritance until 2011, that you consulted several experts and once you understood what you needed to do you acted accordingly to get compliant by taking out the required minimum for the entire period from 2005 to 2012 in 2012. You need to add additional information to make the explanation complete and truthful but you see where I am going with this.

      Let’s look at what amount to take out. If you want to take out the least amount that could be subject to the 50% penalty, then calculate the RMD for each year from age 21 (factor of 62.1) to age 26 (58.2) – see IRS Pub 590 for the full table. Apply these factors (divide) to the value of the account you have to get an amount for each year. For the year 2009, the requirement to take an RMD was suspended so you can eliminate that year’s amount. You will come up with some amount close to $900 for the entire 6 years that you would have been required to takeout RMDs. Take that amount out by December 31, 2012. Then in January 2013 take out the amount for 2013 (about $150) based on your age then and apply that factor to the value at the end of 2012 in the inherited IRA. That shows you being compliant with the rules in case the IRS does not accept your reason on the Form 5329 filed with your 2012 tax return.

      If the IRS denies your reason, the penalty should then apply to only the $900 you took out so any appeal you make is to the $450 penalty they may assess. That might be a small price to pay to keep the inherited IRA and letting it grow going forward.

      Once you get past the IRS scrutiny of the actions you take, you would then be free to take whatever actions you might want in the future. You could continue to take RMDs each year, you could take out more than the RMD, or you could take the full amount out in any year. All your choice at that time to do as you please.

      Be sure to name a beneficiary and a contingent beneficiary for this inherited IRA. If you need some professional help in doing all this, look up a professional tax preparer in your area at http://www.naea.org or a professional financial planner at the Find a Planner at the top of this blog. Finally be sure to have this invested with the idea that this IRA is part of your long term retirement program.

      I hope this has been helpful in addressing your concerns. If you have other questions, feel free to leave another comment

  73. Mr St Onge,
    First, thank you for taking time to answer important questions. I inherited an IRA from my father in December of 2010. I am required to take a RMD and have invested the IRA (worth about 64,000). I just sold stock within the IRA and reinvested it in a long-term bond; the rest of the IRA was in a stock that just called called, leaving 51, 500 not invested. My father left us other money and property, and I invested most of the money. My wife has been disabled and does not work, and I make less than 30,000 per year. We have two children, but have missed out on unearned income credit the past two years because dividends received esceeded a certain amount.
    My question is: Does money taken out of the IRA count towards this part of the tax return? When I have taken the RMD, which is about 1500, I paid the 10% tax immediately. I have made a conscious effort to stay below that dividend threshold this year, but am concerned about the IRA. Any help is greatly appreciated.

    • Michael

      Thanks for your kind comments, I am glad you are finding the articles to be helpful. You have quite a few issues involved in your situation and I am not sure I have enough information to answer all your questions in this venue.

      The question of when you qualify and how much you qualify for the Child Tax Credits and the Earned Income Tax Credit center around your income and the age of the children as well as the type of income you have each year. I used my tax software to try different scenarios of income and ages to see what happened with these credits and the combinations were almost endless.

      This would suggest that the best thing for you to do is to find a tax professional in your area to review the exact specifics of your situation to see what can be done to get you the results that work best for you. Having said that, there are a few things I can provide for you:

      1. The amount of the RMD does not impact these credits in the same way that the dividends received impact the calculation of these credits. The RMD does increase your taxable income so that would reduce the credits you may be entitled to receive. Dividend or investment income is a specific limiter to these credits (see item 3 below), so you are correct to be concerned about the level of this income. I would not however, change the amount of this income just to be getting the credits without first understanding how these credits are calculated.

      2. The age of your children does impact whether you are entitled to the credits. They have to be under the age of 19 at the end of the year to qualify for this EIC credit. If a student in college, then the age limit is under 24.

      3. The dividend or investment income, including capital gains, limit is $3,150 before you are not qualified for the Earned Income Tax (EIC) credit. That is a large amount of income that would suggest you have a large taxable investment portfolio that is generating dividends, capital gains, or interest income each year. You could reduce the amount of taxable investments by using this money to contribute to Roth IRAs or to 401k type programs through your employer. Each program has special rules to qualify but they do take income amounts off your tax return that could then influence the EIC calculation. You could also use US Savings Bonds as a way to earn interest but not have it showing on your tax return each year.

      4. You mentioned that your wife is disabled, have you looked into whether she qualifies for disability income under the Social Security program?

      5. The inherited IRA should be looked at as a retirement asset even though you are taking out a minimum amount each year. As such the investments should be in assets that will grow over the years. The use of a long term bond as a core investment given the low rates of return in today’s environment may not be the best position to be in for the long term.

      Before a financial planning or tax professional could give you more specific advice as to how best to meet your goals and objectives, it would be necessary to review your specific tax situation, your long term income expectations from work, the ages of your children, your short and long term goals and objectives, and the total portfolio of your investments. I do not have enough information from your question to be able to do so.

      I would suggest that you go to http://www.naea.org to find a tax professional and go to the top of this blog to “Find A Planner” to locate someone close to you who can assist you with your financial planning needs. In both cases, you enter your zip code and the web site will provide you with a list of qualified professional who can review the details of your specific situation and work with you on a solution that will be best for you.

      I hope I have been helpful, if you have another question feel free to leave that at this site.

  74. Thank you again for taking the time. My children are 9 and 11. A problem I left out is that I receive $3250 each year as part of my father’s company I inherited. $2100 count toward no. 3, so you see there is not much wiggle room. I just need to be sure that money taken from the IRA does not count toward this number.
    Thanks again, and I did hire investment professionals in the beginning, and it did not work out well. I have spoke with tax professionals and an accountant, and they said they have no experience in this matter and were reluctant to give “advice.”

    • Michael

      Thanks for your follow-up questions, I am sorry that you were not helped by the professionals you contacted but here are a few thoughts.

      The websites I gave you should get you to people who will give advice and be helpful and here is why.

      The Find a Planner tab at the top of this page will get you to a financial planning professional who does more than deal with investment advice. The CFP deals with your entire financial life. The site for tax professionals is to get you to an Enrolled Agent(EA), someone who has been licensed by the IRS to represent people on tax matters. More importantly, they are America’s tax experts and they deal with tax issues for a living. Part of my EA responsibilities is to educate my clients; that is part of every EA’s license. So you should be able to find people in your area to help you with these issues.

      Since you now own a company that is providing some income each year, you have additional tax issues to deal with as well as opportunities to do some tax planning to enhance your wealth and keep your tax liability low. Another reason to get the right professionals working for you. You should also be able to find someone who is both an EA and a CFP who would be able to cover all aspects of your tax and financial planning needs.

      With respect to your two children, you have planning needs related to their future education in addition to your goal of retiring when you desire. The Roth IRA that I mentioned in the previous post is an ideal way to start now to meet both goals with one tool. You and your wife can contribute $5,000 each per year to a Roth IRA ($6,000 when you reach age 50). The Roth IRA grows tax free and is not taxed when you take it out in retirement so all earnings would be tax free after age 59 ½. Between now and age 59 ½, you have access to the annual contribution of $5,000 each year with no tax consequences on the withdrawal (you just cannot touch the earnings before age 59 ½ without having a penalty).

      So if you contributed the $5,000 each year to the Roth by age 18 of your first child you would have contributed $35,000 and your wife would have contributed $35,000 that would be accessible to use for education costs. If that need was not there for any reason then you would have that money available for the second child or for your retirement.

      Good luck with your business and with finding the right professional to help you with your opportunities to grow wealth and meet your future goals and objectives. Again, if you have another question feel free to leave a comment.

  75. Thank you for this site! I was named a beneficiary (along with one other sibling, my twin) to my mom’s retirement account with Vanguard, where she was invested in mostly mutual funds and some company stock. My mom passed away in April 2011 and was under 70 years old, and so had not begun receiving any RMD’s. I know that Vanguard has already split the account into equal portions for me and my sister, and they tried sending me (us) some forms last year to fill out and submit (something about not allowed to hold onto my mother’s company stock since I don’t work for the company she worked for and that I needed to roll over the account by the end of 2011 or take a lump sum?), but I just couldn’t deal with any of it at the time and consequently I have not done ANYTHING with it since my mom’s passing (April 2011). From what I’ve gathered here though, it looks like I have until the end of this year (2012) to take out an RMD to be eligible for distributions spread over my lifetime (as opposed to having to take it all out by the end of 5 years, which I’d rather not do)…is this right? Being December 4th, I guess I need to take action quickly. Do I need to first roll this account over into an inherited IRA before I am eligible to take out an RMD in my name? Or can I do so (take out an RMD) as the account stands? Basically, how do I go about this to ensure that I am eligible for RMD’s over my lifetime? Also, since I am under 30 years old right now, will I be required to pay the additional 10% early withdrawal penalty (in addition to whatever taxes are for my bracket) on every distribution until I’m “of age”? Thank you so much!

    • For clarification, the account name for which I have inherited is called “REVISED PROFIT SHARING PLAN FOR THE EMPLOYEES OF THE GOVERNMENT EMPLOYEES COMPANIES”. Is there a different or specific protocol to follow to begin RMD’s for my life expectancy with this type of inherited account?

      • Kris

        Thanks for your questions as well as your kind comment. I am glad you have found some useful information. Condolences to you and your sister on the loss of your mother, she passed away much too early. You have some great questions so let me try to cover the issues in your two comments.

        You will want to get the account renamed into an inherited IRA for your benefit, Vanguard or whoever holds the account will know how to properly title the accounts for both of you.

        Since your mother passed away in 2011 you definitely need to take the RMD this year for the first year. This RMD amount will be based on your age in 2012. So if you were 29, the factor would be 54.3 that would be divided into the balance of your account as of last December 2011. Use Table 1 of the IRS table in Pub 590 to get the full table. Each year that factor will be reduced by about 1 so in 2013 the factor would be 53.3 and in 2014 it will be 52.4. The factor will always be divided into the account balance at the end of the prior year, so the RMD in 2013 will be based on the December 2012 balance after reflecting that you have taken out for the RMD for this year.

        If your account balance was $100,000, the RMD for 2012 would be $1,841 if you are 29. This would be the taxable income to go into your 2012 tax return. This assumes your mother’s retirement plan is 100% taxable, which it is based on what you provided to me.
        You are not subject to any 10% early withdrawal on this RMD since you are required to take these distributions each year. You can also take out more than the RMD in any year but you must take out at least the minimum for each year.
        You will be taking RMDs every year until your passing, but it would be important to recognize that the RMD amount will grow each year. For instance when you are 65 the factor will be 21.0 (or about 20%) of whatever the value is at that time.
        From a tax planning perspective, you should consider what your current tax bracket is today compared to what it might be in future years. You are at the beginning of your working career and may be in a lower tax bracket today than what you might be when you are age 40. If this is your expectation, then you might want to take out more than the RMD in these early years where you can pay a 15% tax rate rather than be faced with a 25% tax rate when you are earning more at age 40. You might want to also think about using the RMD plus extra withdrawal to fund a Roth IRA for your eventual retirement. If your earned income is more than $5,000 and your taxable income would be in the 15% tax bracket with a $5,000 withdrawal from the inherited IRA being included, then you could use that $5,000 withdrawal to fund the Roth IRA. Your tax on the $5,000 would be $750 but all future earnings on this Roth IRA would be tax free and you would be able to utilize the other features of the Roth IRA going forward.

        You should be sure to name a new beneficiary for the inherited IRA as well as a contingent beneficiary in case something happens to the primary beneficiary.

        I hope I have answered your questions. If you have additional questions feel free to leave another comment.

  76. Thank you very much for all your information. I found it quite helpful.

    I also have a question regarding an IRA. My mother-in-law passed away at the end of Dec. 2011. She was 89 and had begun taking her RMD. My father-in-law is the sole beneficiary. He is 86. However, the RMD for 2012 was distributed before the bank received notification of her death and was directly deposited into their checking account. Nothing has been done with her IRA.

    Any suggestions would be greatly appreciated.

    The RMD distribution was around $400.

    Thank you.
    Berni

    • Berni

      Thanks for your kind comments and your question.

      Given the age of your parents, an RMD would be required for 2012 but would be based on your father’s age. Table 1 of IRS Pub 590 shows the factor to be 7.1 versus the 5.9 factor used for your mother. This means a smaller amount would have been required to be withdrawn, however, more than the RMD can be taken in any year. So your dad is ok as to the amount.

      I would suggest you talk to the trustee of the IRA and see how they are depicting the distribution. They may be able to show it as your dad’s withdrawal since your mother had already passed away in 2011.

      If they indicate that your dad needs to take his own RMD then the amount would be based on the balance as of December 31, 2011, and his age in 2012 (7.1 factor). This should result in a smaller amount than what was distributed to your mother.

      While the account balance may be relatively small, be sure to have a new beneficiary(ies) named for this account as well as be sure that any IRA your father has also has appropriate beneficiaries named. This will make things easier upon his passing.

      If you have any other comments, feel free to leave them

  77. Thank you for you for the clarification. Just one question, however, the bank did the distribution ( in early spring) against her SS# and not my father in law’s SS#. Since she passed away in 2011 she won’t have anything to claim in 2012. (cannot file income tax on the deceased, correct?)

    How should that distribution be handled? Can the bank reverse the distribution under her SS# and put it under my father in laws? I guess I am more concerned about the tax and SS# discrepancy. It will still be deposited into the same account. The RMD calculation would be less since he is a few years younger, which is fine, We don’t care about the amount sincelike you said it is above the RMD he would be required to take.

    However, like I said, our greater concern is distributing the RMD to her and her SS#.

    Any suggestions are greatly appreciated.

    Thanks for your help.

    Regards,
    Berni

    • Berni

      Thanks for the followup question. I would ask the bank if they can be accommodating to change who got the distribution, I am not sure what they will do.

      This would end up being part of her estate tax return which could be a small issue if this were the only item to go on that return. I would suggest you talk to a local tax professional – http://www.naea.org and hit the button for finding a tax professional. That way, you can be sure to get all issues answered at one time.

      It may be that you will have to have an RMD taken for your father to be on the safe side of not getting a penalty.

      Hope this helps.

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  80. Hello…I have recently received part of an Inherited IRA from my mother who passed away this last year. She was under 70.

    I have an advisor suggesting that I split the amount in a low risk mutual fund and the rest in a variable annuity. I am receiving conflicting views on annuities. Any advice? I am under 30 yrs old.

    • C

      My condolences to you and your family on the loss of your mother, she passed much too soon.

      There are many more things I would need to know to adequately respond to your questions about the appropriateness of using a low risk mutual fund and an annuity as the places to invest any moneys you have to put away for the long term. However, here are a few things to consider:

      1. The inherited IRA will require that you take out annual minimum distributions starting this year based on your age and the table in IRS pub 590, Table 1. If you were age 28, the factor to use would be 55.3 that you would divide into the value of the inherited IRA as of the end of 2012. So you need to have the access to at least that amount every year (will increase as you get older) without any fees or charges being assessed for the withdrawal. That is less than a 2% withdrawal in the early years.

      2. You can take out more than the minimum calculated in step one in any year but you cannot take out less without incurring a tax penalty. So be sure you are doing this every year.

      3. The inherited IRA already has the protection of the earnings growing tax-deferred until you take a withdrawal, so I do not see the need for this money to be put into an annuity. Normally, annuities are used to protect the earnings to grow tax deferred until some future date. The IRA umbrella already gives you this protection.

      4. There are many annuity variations so I do not believe it would be valuable to go into each of them without knowing the type of annuity you are being offered. You may want to ask the adviser what type of annuity is being proposed as well as why that type versus some other type or what is being gained by using an annuity when it is already protected as an IRA. You also need to understand what kind of investments would this annuity be invested in for the long term as well as what redemption fees would be charged for any withdrawals that would occur. Part of this discussion should include knowing what kind of commissions the adviser will be receiving from this product each year.

      5. The low risk mutual fund does not sound like it should be a large part of the portfolio (maybe 10%) for the inherited IRA if you are planning to keep the IRA for your lifetime. You are very young and money in a retirement program, whether it be an inherited IRA or perhaps a Roth IRA or a 401k plan at work, has many years to grow. You have almost 40 years of growth to consider for this or any other money you would invest for your retirement. A low risk (meaning low return) that would grow at 3% per year (example only) would double the value of the investment once every 24 years. If you were invested in a mutual fund that was using the S&P index the long term returns have averaged about 7% which would mean a doubling every ten years. Using $10,000 as the value today, it would grow to $40,000 at the 3% return in 48 years versus a value of almost $320,000 at 7% over 48 years. Investing in the S&P Index is more riskier than the low risk fund recommended, but as you can see the return on that risk is much better. Given your age, you are probably in a position to take on that risk for the reward to be received.

      My suggestion to you is to use the Find a Planner tool at the top of this page to locate a fee-only financial planner in your area to review your situation. You should be able to get a free consultation from a planner to discuss your issues. In addition, the fee-only planner is not going to be receiving any commission from any recommendation he/she would make which should take any bias out of the ideas provided.

      A few final thoughts for you. The money in the IRA will be taxable income to you as you take out the annual withdrawals. You are probably at the lowest tax bracket today versus what you will be in for future years as you grow in your job. Assuming you are currently working and have earned income from the job, you could take out more than the minimum amount each year and establish a Roth IRA for yourself as well as for your spouse if you are married. You can contribute $5,000 to the Roth IRA each year, including contributing to the Roth for the 2012 year up to April 15, 2013. So if you desired, you could take out $10,000 now and make contributions to both the 2012 and 2013 tax year for yourself as long as your earned income was at least $10,000 ($20,000 if you are married and wanted to do this for your spouse). If you already use the Roth IRA you cannot put more than $5,000 in for any year, so be sure to take that into consideration.

      If you did establish this Roth IRA then you should be investing in a balanced and diversified portfolio of stock and bond mutual funds with a no-load mutual fund company. No-load means no commissions to the adviser who is involved in helping you. Pay the adviser for her time on an hourly or project basis, not for a percentage of what you are investing. I would not be expecting a fee-only planner to have an annuity as part of the balanced and diversified portfolio.

      You should be sure to name new beneficiaries and contingent beneficiaries for this inherited IRA and for any Roth IRAs you establish. I would also encourage you to research the internet about the many advantages the Roth IRA has so you can appreciate how valuable the Roth IRA will be to you now and when you retire.

      I hope I have answered your questions and provided a road map for you. If you have other questions, please feel free to leave another comment.

  81. HI my mother passed away Dec 2012, and left 91k from a thrift savings plan and 23k from an IRA and 112k from a life insurance policy. I put the life insurance in 2 CD’s and am having the 91k & 23k put into an inherited IRA. I understand that I would have to take out RMD’s every year based on my age (38). how much additional $$ will I have to pay in taxes at the end of the year if my salary is 64k a year? I also filled out paperwork to receive her pension lump sum check which I believe will be around 70k. What can I do with the money to avoid a big tax bill? the paperwork did not have any options regarding rolling over the money, they stated that they can only send me a check for the amount.

    • B.C.

      Thanks for your questions and my condolences to you and your family on the loss of your mother. You have several issues so let’s see what we can do with each of them.

      1. RMD Amounts. You have $114,000 in inherited IRAs and at your age you are required to take out 2.19% the first year (IRS Pub 590, Table 1 -inherited IRA distribution table) or about $2,500. You can take out more but not less than that amount in 2013.

      2. Tax Impact on minimum distribution. If the only other income on your 2013 tax return will be the $64,000 of salary, the tax amount will be about $650 on the $2,500 assuming you were single and had no dependents to claim. If you are married and have children, the tax amount would be more like $400. There could be state taxes as well, depending on what your state tax rules are on this type of income.

      3. Pension Lump sum. If the company does not have a provision to roll this lump sum into an IRA for you, the whole amount will be taxable income. I would go back to them and have that discussion because it will be a much lower tax bill if they will let you roll it to an IRA. If it is taxable, the extra $70,000 of income in 2013 will add another $19,200 to your federal tax bill. There will be state taxes as well but that will be based on the state tax rules.

      4. Insurance proceeds. You are correct hat this inheritance does not have any tax consequences on the amount received, just the future earnings will have tax consequences. This is where the tax planning will come into play.

      5. Tax Planning for the future. There are several issues for you to consider going forward on how to reduce the tax burden on the money you have received and how you manage it in the future:

      a. Use Roth IRA. I will assume for this answer that you are not using the Roth IRA (or the Traditional IRA) in your retirement planning at this time in your life. You can contribute $5,000 to a Roth IRA for 2012 until April 15, 2013, that you can designate to be your 2012 contribution. You can also contribute $5,500 for 2013 to the Roth IRA. If you are married, you can also contribute the same amounts for your spouse if she has not contributed to the Roth or a Traditional IRA for 2012 or 2013.

      b. Maximize the 401k at your work. If your employer has a 401k or similar type plan, you should be sure to maximize your contribution to this program every year. For 2013, the limit is $17,500 and this amount will increase by inflation in future years in $500 increments.

      c. Prior Employer 401Ks. If by chance you have moneys in a prior 401k type program with a previous employer, you should consider rolling that into a Rollover IRA and then consider converting it to a Roth IRA. This move will require you to pay taxes on the amount converted but all future earnings in the Roth IRA will not be taxable income when you take it out after age 59 ½ under current rules.

      d. Other IRAs. Perhaps you have traditional or rollover IRAs from past years that you might want to convert to the Roth IRA. Like the money in item 5.a., this would become taxable income now but the future growth would now become tax-free in the Roth IRA. Since there is no requirement that you convert all this at one time to the Roth IRA, I would do some tax planning and keep the amount converted at the amount that keeps you in the 25% tax bracket each year, so you may need several years to get this plan completed.

      6. Future RMD amounts. Going back to the inherited IRAs for future years, in 2014 and future years the amount you will be required to take out will increase each year as you get older. In 2014 the rate is 2.24% of the balance of the accounts at the end of this year. The balance of the inherited IRA accounts will depend on how you invest these moneys going forward. By age 47 the rate will 2.7% of the balance at that time. In any one year, or every year, you can take out more than the minimum if you had a need for more money or wanted to increase the amounts you are putting into the other type of retirement accounts or to meet other financial goals you have in your life.

      Since you have come into a fairly large sum of money in total (almost $300,000), now is a great time to enlist the help of several professionals to assist you in learning how to effectively manage and grow this amount of money. If you were to reduce this amount by the total potential tax burden included in these accounts (about $40,000 federal plus state taxes), you are looking at a net of $260,000. If you were to average a 7% return until you reach age 65, this amount would grow to about $2 million. By comparison, in a CD for the next 27 years the $260,000 would grow to $750,000 at about 3% per year. So it is important to understand how time and compounding will work for you for the long term in the proper investment vehicles in a diversified portfolio. I would encourage you to visit the Find a Planner tab at the top of this blog to find a Certified Financial Planner, preferable fee-only, to help with this as well as to find a tax professional to guide you on the tax planning (www.naea.org) . There are many professionals that do both so your research may help you find one person to assist with both needs. Look at the fees you pay for these services as an investment you are making to help your money grow better for you to meet your future goals and objectives whatever they may be.

      Finally, be sure to name new beneficiaries and contingent beneficiaries to the IRA accounts to cover where this money will go upon your demise and be sure to also have up-to-date will, power of attorneys and health care directives to cover the rest of your assets and desires. You do not want state rules to determine which relatives will get your estate.

      I hope you have the answers you need, enjoy the legacy you have received from your mother. If you have additional questions, feel free to leave another comment.

  82. Wow thanks a million for your responses ! I will definitely follow your advice and seek out a pro to help manage the funds left by my mom. I thought I would be able to tackle this on my own but am finding out I have lots to learn about managing my finances correctly. I will also callback her employer to get solid information to see if I can rollover her lump sum pension election.
    Again, thanks , I appreciate your time and condolences.

    • B.C.

      I am glad that the information was helpful to you. It is always nice to hear that the client is learning and wants to enhance the legacy they were left. Let me know what you find out about the pension options.

  83. Heidi A.R.
    Is a RMD or any distribution from an inherited traditional IRA exempt from taxes if the new owner uses it for higher (college) education expenses. Both of my daughters have inherited traditional IRA’s from their grandmother/my mother. The value of each is $4700.00
    Daughter number one, a 22 yr old college senior graduating in May, has college loans to pay. She just elected to take a total distribution of the fund as she will be in a lower tax bracket hopefully this year (having lower earnings than when her salary is for a full year in 2014) She had planed on reinvesting it into a Roth IRA in 2013 leaving opportunity for investing the full amount allowed for 2014. But, can she avoid taxes all together if she writes a check for that amount to pay a student loan off.
    Daughter number two. a 19 yr old, will be a college freshman next year.
    Another consideration is that there is also a pretty heavy administrative fee for each distribution, $49.95 which will eat up a fair amount of earnings.
    I also an have inherited traditional IRA from my mother and had intended on stretching the investment and taking only the new minimum RMD. Can I use mine to pay for my daughters’ higher education…without paying taxes and save constantly paying $50 each year.

    Thank you
    Heidi A. R, from Missouri

    • Heidi A R

      Thanks for your questions on inherited IRAs. Your daughters have received a nice legacy from your mother as have you.

      Any distribution from an inherited IRA will be considered taxable income to the heir unless there are portions of the IRA that are considered cost basis. The cost basis would be for contributions that your mother may have made to an IRA for which she did not take a tax deduction on her tax return in the year of the original contribution. If this IRA was from a 401k or 403b type program through your mother’s work place then all moneys would be taxable income and thus no cost basis.

      When IRAs were first available many people would contribute to an IRA because they could take a tax deduction on their tax return which made this much like a 401k contribution which makes all amounts taxable. However, some people made too much money and were not able to take the tax deduction but would still contribute to the IRA. In these cases, the contribution amount became what I called the cost basis. Since no tax deduction was taken the contribution should not be taxed when the money is taken out later. This may require you to have available the tax returns for your mother to make this determination. If you know this IRA was from her work then this is not an issue to worry about.

      The idea of taking the distribution and then reinvesting it in a Roth IRA is a great idea. It appears that daughter one has earned income so she would qualify to contribute to a Roth IRA in an amount equal to her earnings or $5,000 whichever is lower. If she had earned income in 2012, she can still contribute to the Roth IRA for last year up until April 15, 2013. I would encourage her to do that because then she could still contribute to the 2013 Roth IRA if she has earnings in 2013.

      Since the daughters are in college and I am assuming paying tuition, they would be entitled to one of the several tuition credits that are available. If you are claiming them on your tax return, the credits would probably go on your return but if not then they can claim these on their returns. You just cannot claim the credits on both returns. I would suggest you look at which way provides the best results for claiming the credits and file that way and share the results.

      With the student loan, the interest paid is tax deductible by reducing the amount of income that is taxed so this may help to reduce the tax burden from the IRA withdrawal. Based on the facts you have presented, my expectation is that there will not be much if any income tax due on the withdrawal of the $4,700 from the IRA for either daughter.

      With respect to your inherited IRA, whatever amount you withdraw will be taxable income on your return. What you use it for has little bearing on the tax consequences. You are not limited to the RMD amount each year, so you can take as much as you want in any year. So you could have a plan to take out $5,000 each year to make your Roth IRA contribution even though the RMD amount was only supposed to be $1,000. The $5,000 would be taxable income so you might want to be sensitive to what tax bracket you will be in for the amount you take out. I recommend to clients that they look at taking out as much as what will keep them in the same tax bracket they are currently in. For instance, if you are in the 15% tax bracket and could take out $4,000 from the IRA and pay 15% tax, then do that. If you took another $1,000 out and that pushed you into the 25% bracket, then the last $1,000 would cost you $250 in taxes.

      The fees for the withdrawal are probably related to where (bank or mutual fund company) you have the IRA invested so you may want to look around for other places to have the IRA. But when shopping, be sure to consider how the money is being invested with the new trustee. If you were invested with a trustee who was only going to pay you 2% with no fees that might not be as good as paying a $50 fee for a withdrawal and getting 4% return on the money.

      Too often, a client is looking at the current period and the current tax on what is happening now rather than taking a longer term view of what will happen to this money in 20 or 30 years. If you look at it from this view, you will see that the Roth IRA is where you want your money and your daughters’ money to be for the long haul. This view tends to diminish the current tax issues because of the many advantages of the Roth IRA that I have mentioned in prior posts. For instance, paying 15% tax on $4,000 today that will grow to $16,000 in 20 years if earning 7% annually and is tax free in a Roth IRA makes the $600 in taxes seem pretty small.

      You may be helped by engaging a tax professional or a financial planner in your area to assist you with the various issues I have noted. You can find a planner at the top of this page under “Find a Planner” and a tax professional at http://www.naea.org.

      I hope this answers your questions, if not please feel free to post another comment.

  84. So many good things to think of! Thank you very much for your assistance and time.

  85. What happens if the father didn’t take his RMD and he passed late in the year, ie, December. Does Lucy have to take the RMD asap in Jan of next year? Does the tax go against the father’s last income tax return if it wasn’t taken until until the following year, or does Lucy pay the tax?

    Thank you!

    • Deb

      Thanks for your question and my condolences to you and your family on the passing of your father.

      An RMD is required for every year after one reaches age 70 ½. When an event such as a death occurs and the RMD does not get taken by the owner of the IRA, the beneficiary must first take that RMD even if in the next year before the IRA can become an inherited IRA.

      The amount of this RMD will be reported to the beneficiary, Lucy in your example, and will be included in the income for Lucy in that year. The inherited IRA balance then becomes the amount used to determine the RMD that Lucy needs to take in the first year. The amount of her RMD will be based on the inherited IRA table found in the IRS pub 590.

      Since the father passed in 2012, Lucy would have to take her RMD by December 31, 2013. This amount and the RMD for the father, also taken in 2013, would be income to Lucy for 2013. The amount of tax due on these two withdrawals will be based on what other income is being reported on her tax return for 2013.

      Be sure to check on whether there is a cost basis in this IRA. This information can be found on the last tax return filed by the father on Form 8606. If this IRA came from a work related 401k/403b type program, there will be no cost basis and all income will be taxable. Cost basis would occur when a person contributes to a traditional IRA outside of work and no tax deduction was taken for this contribution. The contribution amount that was not deducted is considered the cost basis and it came from after tax money which is why it will not be taxed again when withdrawn.

      Also have Lucy name a beneficiary and a contingent beneficiary on the inherited IRA so if there is any remaining balance in this IRA upon her demise, the IRA can pass to the beneficiary easily.

      Hope this answers your questions. If you have more questions feel free to leave another comment.

      • Wow. First, thanks, Francis, for such an informative post and your continued contribution via all the comments! Amazing.

        I have a question re comparing your response to Deb and what you wrote in the original post:

        In the original post, you wrote, “Under these rules, Lucy would have to take the RMD for 2010 and receive it as a beneficiary of his estate…The $8,502 was an RMD by her father’s estate and received by her. This is not taxable to her as an inheritance but would be income to be reported on her father’s last return.” (i.e., father’s RMD after death reported on father’s return)

        In the above response to Deb, you wrote, “Since the father passed in 2012, Lucy would have to take her RMD by December 31, 2013. This amount and the RMD for the father, also taken in 2013, would be income to Lucy for 2013. The amount of tax due on these two withdrawals will be based on what other income is being reported on her tax return for 2013.” (i.e., father’s RMD after death reported on Lucy’s return)

        Can you provide some clarity re on whose return the income related to the remaining RMD in the year of death is reflected? The father’s or the daughters?

      • Galen

        Thanks for your kind comments and I am glad you found this helpful. I am equally impressed with your commitment to reading through all these issues and that you were able to see how complex these issues really are.

        In the example you presented, I would be looking at the specifics of the client and make my decisions that way. By that I mean, the withdrawal of the deceased RMD would normally be coming from the account of the deceased and thus be under that SSN whereas the RMD of the heir would be coming from an inherited IRA account that would have the SSN of the heir.

        In the event that the inherited IRA account had been set up and the RMD of the deceased had not been taken out before this new account was established, then I would expect the trustee of the new account would be using the SSN of the heir for both distributions. In this case I would probably report both on the same tax return of the heir.

        While this may seem not proper reporting, I would be looking at it from the way the IRS records would be reflecting these two transactions in their records. I would also be considering what the ultimate tax consequences are for both withdrawals. I would expect that the difference would be small in amount and that the IRS did get their tax money which is their prime interest.

        If you tried to report the deceased RMD in the second example on the deceased tax return when it was reported on the SSN of the heir, this would be the correct way, however, I am not sure this preciseness would be worth the effort needed to do so.

        I hope this helps with what should be done. If you have another question, please leave another comment.

      • That makes sense…to include it on the return of the person to whom the distribution will be reported. If the distribution were paid after death to Lucy’s father or his estate, it seems the cash would be an asset subject to probate and the distribution would be reported against her father’s SSN or the estate’s tax ID. If the distribution, however, was made out to Lucy, it would be because the account had already been changed to a beneficiary IRA and would be reported against Lucy’s tax SSN.

        Thanks again for the great post and follow up comments!

      • Galen

        You are right on target, hope all goes well with the inherited IRA.

  86. My brother recommended I may like this blog. He was totally right.
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  87. This is the perfect site for everyone who hopes to understand this topic.
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    • Pistol

      Thanks for the nice comments, I hope you have found information that was helpful to you. My only purpose is to provide information that is helpful to those who most need it.

  88. I have an inherited IRA that I inherited from my aunt when she died at the age of 68. I starting taking a minimal annual distributions based on my life expectancy. Have done that for seven years. Am I stuck doing that for the rest of my life or can I take out a larger amount?

    • Ruiter

      Thanks for your question because it is at the heart of how the minimum distributions rules work. As you have been doing, the minimum is what is required but you can take out more than that in any one year or every year.

      Since you have been taking the minimum, you have had experience as to how that amount has impacted your tax liability. If you take more than the minimum, then you may have more tax to pay and you may even push your taxable income into a higher tax bracket with that larger distribution.

      So I would suggest that you check with your tax professional first to see what tax rate will be applied to the larger amount you want to take out in any one year.

      If you continue to take the minimum amount each year, the rules are intended to have the IRA completely taken out by the time you pass away assuming you live a normal life. As you have also seen, the amount you are taking out each year is becoming slightly higher as you age, again what the program rules intend.

      For some people I recommend they take enough out each year so they may use that amount to contribute the maximum allowed to a Roth IRA (assuming they are not already doing so). While you have to pay taxes on the amount withdrawn, by putting it into the Roth you are further deferring the earnings in the Roth as being non-taxable and they do not have minimum distributions required from a Roth IRA. To do this contribution to a Roth IRA, you need to have earned income from a job or self-employment equal to or greater than the amount you want to contribute to the Roth IRA. The limit for 2013 is $5,500 and $6,000 if you become age 50 in 2013 or are older than age 50 now.

      Hope this answers your questions, if not feel free to leave another comment.

  89. I owe restitution, and I have to pay 60%of what I inherit to The Feds. If I inherit an IRA, and roll it over, will the total amount be taken in consideration to pay 60% of it, or just my distributions?

    • Bobby

      Thanks for your question which has several unique issues to address. Unfortunately, I think this is beyond my knowledge level to provide you an answer at this point. Here are the issues that need to be flushed out that an attorney would be the better person to assist you:

      1. The reason for the restitution order needs to be better understood as to whether it is a state or federal level issue.

      2. Whatever amount would be withdrawn in any year would be subject to federal income tax and perhaps state income tax (state rules vary by state) that will need to be considered.

      3. Inherited IRAs require a minimum withdrawal each year from the date of death. Once withdrawn, this money is no longer under the protection of the IRA rules, but taxes may be due and the balance may be subject to the restitution order, again a legal question.

      4. State laws vary from one state to another and different courts in the same state have reached different conclusions on issues like this, thus the need to get legal advice from an attorney in your state.

      Since I am not a lawyer, I would not be able to go further than what I have provided here. Contact the local bar association in your state and ask them to assist you in finding an attorney who can assist you with these issues.

      I hope I have provided you some answers and direction for your question.

      • when I deposit the check from the attorney who distrubutes the check, how shall he make it out, and how shall I deposit it. Just in my current IRA ACCOUNT? Thank you,

        ________________________________

      • Robert

        Thanks for your question, however, I am not sure I understand what you are really asking. If the check is from an inherited IRA that you are the beneficiary of, the issue would be tied to what you are wanting to do with your share of the inherited IRA.

        If your desire is to have the inherited IRA stay as an inherited IRA, you would want to have the check made out to the trustee you have selected to hold the IRA for you. This might be the mutual fund comonay where you have your IRAs, however, you would wnat it as a separate inherited IRA held for your benefit.

        Should the attorney make the check out to you directly, that will be considered a disbursement from the IRA to the benficiary (you) and it will be totally taxable (less any cost basis that may be in the IRA) in the year you recive the check.

        I would suggest you want to talk to your financial planner professional (see the Find a Planner tab at the top of this page) or your tax professional (www.naea.org to find one near you) to be sure that this transaction is handled properly.

        If you have another comment, feel free to post it. Hope this helps.

  90. Here is the problem I have: my brother-in-law John died Jan 29, 2013 in CA of heart failure. He lived in Santa Rosa, CA and left an IRA with stated value of $340,000 to his sisters Kathy (my wife) and Dianna to be shared equally. It is in the estate but not in John’s trust. Kathy is now 76 and we have an RMD problem. If Kathy declines the IRA it will go 100% to Dianna, who in two years will have an RMD problem. A large firm (call it BIG as you probably do not want the name public) holds the IRA inside an LLC and specializes in “Alternate Investments”, In this case mostly invested in property. and 2 others. MID, another LLC, manages the property (a building in West Oakland, CA) Probably BIG sets the value of the asset at $340,000 (its basis is listed as unknown on a quarterly report we received) . John’s IRA, inside his LLC, is one of several investors in the building. BIG take their cut of $1200 per year from part of the money generated by MED in managing the property. to my knowledge there has never been any money distributed to John and MID told me there were no plans to liquidate the property. I have been unable to get an articles of incorporation from wither BIG or MED, although I have an estate lawyer who is in the loop and have discussed this with three different financial advisers and our personal tax professional

    If Kathy accepts the inherited IRA then she (we) have RMD concerns but Kathy has no IRA and John’s IRA is not liquid. We don’t know where the money will come from. MED said there are no plans to sell. We have tried for the past 2 mos…mainly with our estate lawyer in CA…to get further info but do not know much, if anything, more. For me “Alternate Investments” means property, hedge funds and the like…probably any investments that they would like to keep hidden from view, like for the very wealthy who tax shelter their monies until a later date. I do not know, not can I find out yet, if BIG like IRA investments through companies like BIG have a time period after which they are obligated to actually distribute cash out of the IRA.

    Any comments will be appreciated. Thanks

    • Bob

      Thanks for your questions and my condolences to you and your family on the passing of your brother-in-law. You have raised some very important issues related to IRAs and to self-directed IRAs in particular.

      You have already done extensive investigation on this IRA so it looks like you have a good understanding on the real issues you are facing. For starts, you have what looks like a very ill-liquid investment that is faced with the minimum distribution rules that the IRS has in place requiring some amount to be taken each year from the IRA and reported as income on a tax return.

      Since the brother died in 2013, the first distribution would not be required until 2014 so you have some planning time to resolve the issues you face. This is assuming you wanted to take an amount each year for the remainder of the sister’s lives. You also have the option of using the five year rule which would give you five years to make this a liquid asset. The five year rule would require the entire amount to be taken at one time during or before the end of that five year period.

      Using the $340,000 value split between the two sisters, the RMD amount needed by Kathy would be $14,049 to be taken by December 31, 2014. For Dianna, the amount would be $9,550 by December 31, 2014. The ages of each sister determine the amount required to be withdrawn and is not related to whether they are under or over age 70 today. If Kathy disclaimed, then Dianna would have to take out $19,101 the first year. I am using the Inherited IRA RMD table to get the factors for each sister based on their age in 2014. Inherited IRAs do not have the same rules as the rules used by the original owner of the IRA.

      You indicated that the value of the asset was estimated at $340,000. The IRS requires that the value be established at December 31st of each year, so a value will need to be determined by the end of this year to set the amount to be taken out next year. Again, I am providing you some time to figure out the right solution.

      Since this is in an LLC type organization and the IRA account is one of several owners, there would be some provisions in the articles or by-laws for owners to be able to sell their share of the asset. The sale could go to some other owner or to a new owner (maybe the estate of your brother if that was a desirable investment to keep?). Since this “sale” may be under a duress situation, the value might not be what you would want but it would free up the value so that the RMD plan could be implemented.

      Once you were able to get the value in the IRA to be cash versus the property, you could then transfer the IRA to a regular inherited IRA with a mutual fund company and then establish an investment portfolio for the longer term that would grow and also provide the ability to have the RMD amounts withdrawn each year as required by the IRS. This would be true whether each sister kept her share or the entire amount went to just one sister.

      At this moment, I would see an 18 month minimum period to get a resolution to the issues and then it becomes a five year window to get it resolved. The five year window is not the ideal solution because that will mean complete liquidation of the IRA in that time period and the complete reporting of that withdrawal as income on the sisters’ tax returns when that happens.

      When you establish the new inherited IRAs for each sister, be sure to name new primary beneficiaries as well as contingent beneficiaries to provide the best options for the future.

      For others who may have self-directed IRAs, now would be a great time to re-evaluate if that is the best way to have your assets in your IRA invested, particularly if you are approaching the age when RMD amounts are required. You have to be able to answer the question of where will the cash come from to take that RMD amount each year if the asset invested in is illiquid like this asset appears to be.

      As a final note, Bob, you did not mention if there were other IRAs that John may have had. The RMD rules only require that an RMD amount be taken each year. It does not require that the RMD come from each and every IRA that a person has. So if there are other IRAs in more liquid type assets, you could calculate how much the total RMD is for all IRAs and then take that amount from another IRA account.

      I hope I have been of some help in this very complex issue. If you have more questions, feel free to leave another comment.

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  92. Hey! I understand this is sort of off-topic however I needed to ask.
    Does operating a well-established blog like yours require a massive amount work?
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    • Thanks for your question, but I am not sure I can be of help to you. My role is to write the articles and respond to the questions left by readers. The FPA did all the work in setting up the web site and the support needed to do the work behind the scene, so I have no idea what that work required. Might try calling them for assistance.

  93. I was the bebeficiary of an inherited IRA about six months ago and rolled it over. I would like to use it as part of a down payment for a home. MY financial planner has advised against it (as many seem to do). I have my own 401K that I contribute to the max and a retirment pension. I undestand the tax implications, but this money (like a 401K) will be taxed anyway; wheter now or in the future. Why is everyone so skittish about withdrawing the money as part of a first-time homebuying transaction?

    Gilman

    • Gilman

      Thanks for your excellent question on the reasons for using or not using your IRA money for the down payment. Let me try to help out with some of my ideas.

      Since you provided no facts on how much we are talking about in the various investments, time frame to retirement, cash flow needs now or later, my comments will have to be somewhat generic.

      With most people in America not saving enough for retirement, most planners including me are reluctant to suggest that money already in an IRA be used for anything other than retirement. I understand that you may have great intentions to save enough and may also be fortunate to have a pension that will be available when you retire, that is not where the majority of people are today. And we know that all of us have great intentions but we fall short in many cases in completing those intentions.

      Now, if I had the information about you and could see that you would have sufficient assets to be able to retire on (and live for another 30+ years), I might be willing to go along with your idea. I would hope that your planner has spent time explaining to you why he/she feels the way they do about not using this money for the down payment.

      As for the issue of eventual taxation of what you are saving in the various investment vehicles you have, I would agree it will be taxable. Where we might have differences of opinion is what tax rate will you pay when you do take out the money in these various accounts. With proper planning, you might be able to reduce or eliminate much of the tax on these funds. That is what you pay your planner to do in helping to reduce the level of taxes on these funds when withdrawing and to also help grow the assets in a tax deferred manner while you are saving for retirement.

      For instance, taking from the inherited IRA today might mean a tax rate of 28% or 33% (your incremental tax rate today) versus in retirement the incremental tax rate might only be 25% or even 15%. Perhaps your planner or tax professional can model what your tax situation might be in retirement and compare that with what you would pay today on money taken out of the inherited IRA.

      Much of the work I do for a client in this area is spent in developing the plan for how we save money today in the proper vehicles, properly invest it to grow, and then to have a plan for how we can use this money in a way that we pay the least amount of taxes over the long haul. The less tax we pay, the more we have to spend on ourselves and the more we keep to share a legacy with our heirs or give to charity.

      You did not mention if you had any taxable money to make the down payment on the new home. Assuming you do, I would be encouraging you to use that money rather than the inherited IRA because that will take money that is creating current taxable income in the form of interest or dividends off your balance sheet thus reducing your current taxable income while allowing the IRA money to continue to grow tax deferred.

      Hope this gives you that second look at what you want to do. If you have more questions, feel free to leave another comment.

      • I have 300k in a 403b to which I max contribute and a pension that will pay me close to 100k annually. I have about 20 working years left.I have 65k liquid. I live in Manhattan so RE is very expensive. Using the liquid and the inherited IRA (50k pre-tax) covers 20% dp, closing, and 9 months payments liquid.

      • Gilman

        Thanks for the follow-up information. Looks like you are doing a great job at saving money for retirement with plenty of years left to build future retirement amounts. If I had a client with these issues here would be some of my suggestions to that client:

        1. If the employer were providing matching contributions to the 403b, I would encourage continuing to contribute an amount necessary to get that match as the match is free money to you.

        2. I would encourage contributing to the Roth IRA in addition to the amount going into the 403b. The limit is $5,500 if under age 50 and $6,000 per year if you reach age 50 this year. There are income limitations on contributing to the Roth IRA so you may have to contribute to the traditional IRA first and then convert that to the Roth IRA. If you are married, your spouse can also contribute similar amounts to the Roth IRA based on your earnings history.

        3. Since you only need to take a minimum withdrawal each year from the inherited IRA, I think the amount would be about $1,300 per year. You can take out more and I would do so over several years. In this case, I would want to check the incremental tax bracket to be sure you are not pushing yourself into a higher bracket by taking out the entire amount from the inherited IRA in one year. Again, your tax professional and financial planner would be the ones to consult on this.

        4. I would also be checking on the pension amount to see if that is based on how long you have worked to date or if it includes future years of earnings in the calculation of the $100,000.

        5. Finally, I would want my client to understand how his numbers would be impacted if he were to suddenly be unable to work and continue to contribute to the 403b and his pension benefit. This could be due to injury or layoff from his current employer. These are real risks and would have serious impacts on how his retirement funds would grow over time.

        In your situation, I would encourage you to have a meeting with your financial planner and your tax professional to be sure they have been updated on your changes in financial wealth as well as focus on the above issues.

        Hope this helps, let me know if there are additional questions you have.

  94. First off I would like to say that your blog and the information that you provide to others is absolutely outstanding. I have never come across a page that has been so straight forward, clear and thoroughly helpful in so many ways. You do yourself a credit to your profession and those you help.Thank-you.

    I have many questions in my personal situation, one which is long and complicated. I will start off with an initial query.

    Unfortunately my Father is in very ill health as of this moment and not long for this world. We lost my Mother in 2002 and he has since remarried his Brothers (also deceased) Wife (my Aunt) in 2003. It was a mutual agreement between the four of them and they are happy as we all are also for the both of them.

    My Father and his Wife (my Aunt) both have their own separate monies that they have put in a trust for all of us. What they did is, put the monies that were earned before they got married into trusts for the individual families, after that day they put the now earned monies in a trust that would be divided among the remaining siblings.
    We had 3 Brother’s on our side and just lost my middle Brother last December 2012 (I am the eldest and executor) and she has 3 Daughter’s… (I know… the Brady Bunch, sort of?)

    Several years back in 2010 he told me that he was “prepaying” on mine and my Brothers main inheritance/ trust (there are others) all of the taxes so that we would not be liable for said taxes. He said that he had to do this in a small window under the “Bush era tax breaks before they ended” … What he said when he payed the first $75,000 that by the next year he had to pay over $125,000 for that second year.

    My questions are, what is that special tax break called for that time period? I can not seem to find any information about it. With that kind of “pretax payment” amount, is this a sizable IRA? He had by the beginning of this year 2013 (which he was able to do and had to do) change this IRA over to a special Roth IRA which is now just divided between myself and my remaining Brother. My father has many IRA’s, collects 5 separate pensions and has many investments.
    My father has been trying to explain this to me, but unfortunately; he is now no longer able to do so.

    Thank-you again, I have quite a few other financial complications to add to this… with other monies that I am receiving in separate situations. I will address those later on, but here is the history:
    My Father is 77 years old and already been taking RMD’s and dispersing 13k each year to all of his/their children. I am now unfortunately totally disabled and do not know how much time I have left either, I actually thought that my Dad may outlive me after an airplane accident that I had working as a crew member (the accident was even on CNN) on October 10th, 2008. I took this year at the age of 54 an early out in the amount of 40k from my airline after 30 years of working in this career and will start my pension this March 1st, 2014… I collect SS Disability and will finally be settling a worker’s compensation settlement after 5 years of battling this arcane system (another story for another blog/board).

    Thank you again in advance. Can I hire you?

    • Eddie and Jody

      Sorry I have been so long in responding to your comments, too many emails coming into my mailbox. I also offer my sympathies to what you are going through, I know it cannot be easy.

      It is nice to meet someone who can give me a similar story to my parents’ parents. I grew up being able to say my Mother’s mother married my Father’s father and it took people awhile to really understand what I had just said.

      Here are some answers to your questions about what your father has done:

      1. The special tax law you may be referring to was the opportunity in 2010 to convert IRAs to Roth IRAs in that year and elect to pay the tax in 2011 and 2012. So if this is what your dad did then he now has Roth IRAs and does not have to take minimum distributions from the old IRAs that are now Roth IRAs.

      2. It is not clear if your dad converted all the IRAs to Roth IRAs, so if he still has IRAs then he still needs to take a minimum distribution from the IRAs that he still has. He can also continue to do a conversion of the remaining IRAs to a Roth IRA but he does need to take the minimum distribution for 2013 before he does any further conversion.

      3. Now, the really good news as it relates to the Roth IRAs. He does not need to take any money out of these in the future if he does not need this money to meet his expenses. Assuming he does not take money from these Roth IRAs during the rest of his life and these become part of the inheritance that you and your brother will receive upon your dad’s passing, then each of you will receive this as a Roth IRA. The rules requires that you start taking a minimum distribution each year going forward based on your respective ages AND you will not pay any income tax on these moneys because your dad took care of that in the past two years!

      4. I would be guessing on the size of the Roth IRAs but I think we are talking a substantial amount of money that is in these Roth IRAs. There are a few things that I think you need to address for all the assets your dad has (these ideas would apply to your assets as well). Be sure that each IRA/Roth IRA has at least one primary beneficiary (or two if meant for you and your brother) and also consider having contingency beneficiaries named as well. The contingency beneficiaries are there to deal with two issues. First, if you and your brother were to pass away before your dad, then the contingent beneficiaries would be the ones to receive these moneys. Secondly, if for many reasons the money in the Roth IRA was something you did not need and wished to pass on to someone else, like your children or nephews/nieces or anyone else you would want to receive these moneys. Then you could disclaim these moneys and let it go to the contingent beneficiary named on the Roth IRA.

      5. If you are the executor for your dad, now would be a great time to be sure you have as much information on all his assets so you can determine if there are any inheritance taxes that may apply to his estate. So you should start by listing all the assets he has whether in a trust or not to determine what the value of his assets are so you can compare that to what the estate tax exclusion is of $5.2 million. You should also review what his various trusts say as to who are the beneficiaries of the trusts and be sure there no surprises in this document. For example, maybe one of the beneficiaries is receiving income that would prevent them from inheriting money because they are a “special needs” person. In that case, there would need to be a “special needs” trust established for that person so they do not receive this money directly but would go into this trust for that person’s benefit.

      6. Since it appears we are talking about large sums of money, it would be important to be sure these assets are appropriately invested in a diversified portfolio. Sometimes I find individuals in this age category want to protect the principal and they are not properly invested to grow the portfolio.

      7. I would suggest you go the “Find a Planner” tab at the top of this blog to locate a financial planner near you who is a “fee-only” planner or go to the http://www.naea.org to find an Enrolled Agent who is a tax expert to assist you with making sure the complexities of your financial situation are being handled correctly. You may also need an attorney who specializes in estate planning to deal with the legal documents. These would be moneys well spent to be sure there are no issues being overlooked.

      I hope you find this information helpful and answers most of your questions. Please feel free to post another comment if you have more questions.

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  102. Hello, Mr. St. Onge

    I don’t know if you’re still responding to questions here on your blog (It’s very informative, thanks so much!) but I have a (what I hope) is a somewhat easy question for you. My mom passed away last July 2013 and I am the only beneficiary of her IRA account, which I didn’t even know existed until I found the statement in piles of paperwork in her home while cleaning up after her passing away. About a month later, I contacted the Custodian of the IRA and notified them of her death, and they failed to tell me that there was a RMD that would have been distributed on Dec 31, 2013 but wasn’t made. In fact, they only confirmed to me that I was the beneficiary and not much more, just telling me where to download papers to transfer the IRA into my name. My feeling is, they should have informed me that there was an RMD issue to be addressed before year’s end, or that there would be tax consequences.

    Long story short, I only found out today that the account was locked and no RMD was made for 2013. Now I understand that it should have been made but wasn’t, and there may be a 50% penalty on the non-distribution. I also understand that there was no way a distribution could be made since she had died, and I didn’t know that I had to take the distribution as the beneficiary. The amount isn’t huge, the IRA is only about $25K and the RMD was around $700 for her – is the penalty based on the amount she should have taken or the amount I should have taken if I had transferred the IRA into my name before the end of 2013?

    All this is very confusing and hard to sort out, and I had no idea of the law or consequences before today. I think I can ask for a waiver of the penalty for cause (what excuse to use?) but should I take an RMD out now, and send paperwork to the IRS describing the reason for the failure to take it out before the end of last year, or what? I’m kind of lost, so I hope you can point me in the right direction.

    BTW, she had been taking the RMDs in all prior years without fail, it’s only last year’s that didn’t happen because she died and couldn’t take it out. She was 88 years old when she died and obviously she knew about the RMD. If I had known about the existence of the penalty I would have done something last year. The Custodian (T Rowe Price) didn’t mention it at all during the conversation last August when I verified I was the beneficiary.

    Thanks very much for any information you can tell me.

    • Rob

      Thanks for your question on your Mom’s IRA and my condolences to you and your family on her passing. You have identified several issues that are fairly common so lets deal with each one.

      Yes, an RMD based on your Mom’s age needs to be taken and should have been taken last year. But we are close enough to last year to make the issue rather benign in the end.

      You should take the RMD first and my calculations are the amount should be about $1,968 ($25,000/12.7). The 12.7 is the factor I got from Table III for RMDs from the IRS web site. If you search for IRA RMD Table you will get this table to show up. That RMD amount will be paid to you and you will get a 1099R from the trustee at the end of 2014 so you can include it on your tax return. I am not sure how you arrived at the $700 so you may want to check on that.

      You also have to take an RMD from the inherited IRA for 2014 but it is based on a different table (Inherited IRA RMD table) assuming you are in your 60s, the factor will be somewhere between 25.2 and 21, so your RMD will be smaller. It is important to note you need to take the minimum but you can take more if you wish in any year.

      As to the concern about the IRS penalties, you may at some time get a letter from the IRS assessing a penalty but I would not be concerned at this time. I would wait for the letter to show up in your mail box. Should you receive such a letter, the rationale to use in asking for relief from the penalty is exactly what you have given me as to how this happened, especially the part about the lack of proper education from the trustee. If you are uncomfortable dealing with this yourself, I would go to a professional tax preparer to help you with the letter. You will find one at http://www.NAEA.org where you can search for an Enrolled Agent who specializes in taxes in your area.

      Now, the next thing we need is an action plan to deal with the rest of what you should do:

      1. Transfer the Inherited IRA to a trustee who knows what needs to be done. I would suggest a major mutual fund company (not the current trustee) that has no-load mutual funds available to invest the IRA. There are many and just searching for “no-Load mutual funds” will get you what you need. The fund family you choose will do all the paper work for you once you provide them with the statement of the current trustee.

      2. Be sure to name a new beneficiary for this IRA and a contingent beneficiary as well. You can name more than one of each but at least be sure to name one.

      3. As for the RMD each year, you can set this up to automatically occur every year on whatever date you want. The trustee will do this for you when you meet with them.

      4. Given the low dollar amount of the IRA and the RMD each year, it may not be real important to do this next item, but you may want to see if the IRA has any “cost basis” that would reduce the amount of the RMD that is taxable. If your mom established this IRA by making contributions to it each year and did not take a tax deduction for that contribution, the contribution amount would be the “cost basis” that would not be taxable. If she was doing things correctly by filing a tax return every year, the answer would be on Form 8606 of her tax returns. If this IRA was from a 401k that she or her husband had that was rolled over to an IRA, there would be no “cost basis” and every dollar would be taxable income.

      5. While she may not have any significant income in 2013, you should make sure that final tax returns are prepared for her and her estate. The final one for her is under her SSN for the period from January 1 to her date of death. The second return would cover the period from her date of death to the closing of her estate or through June 2014. This second tax return will require getting a separate EIN number from the IRS for her estate. Your tax professional can help with all of this. This second tax return would be reporting any income or expenses that are tax deductible that were paid by the estate. These income and deductions will be reported on the return but you as beneficiary will be able to report these items on your personal tax return for 2014.

      I hope I have answered your questions. If you have any additional questions, feel free to leave another comment and I will respond.

      • Hello again, Mr. St.Onge, I wanted to check back in with you and thank you so much for the very useful information you provided to me in your reply to me. You were correct about the IRA distribution, in fact, soon after your reply, they sent me a check for the RMD. It was around $1500 as you noted. So I elected to take my RMD around the end of the year, which will be much less than the amount my mom was required to take. Thanks again very much for your detailed explanation. This has been a huge help to me to understand what I have to do as I try to complete the proceedings of my mom’s estate.

        I did have another question, if you don’t mind me asking. As you said in your last point (#5 in your list), there may be tax returns due shortly. I know she didn’t have enough income from Social Security or dividends that would necessitate filing a return, since she died on Jul 1 of last year. Is it 100% mandatory that I file a return for her? I’m not even sure she filed one for several years, since her income was very low and I know she wouldn’t have bothered if she didn’t have enough coming in to make the filing threshold.

        I already have the EIN for the estate, which I had to get when the estate was opened, in order to have an account in the name of the estate. I think, if I read correctly, I have up to three months after the estate is closed in order to file an estate tax return. Am I correct in assuming that all income from dividends that were received after her passing have to be attributed to the estate, and can’t be included on her tax return? I think the estate only gets a $600 deduction, far less than the individual deduction. Could this dividend income be considered IRD (in respect to decedent) instead and added to her return (assuming I have to file one)? Also, are the attorneys expenses deductible against the income of the estate, on the estate return? I had to pay $24000 to the attorney to process the paperwork, I’m hoping there is a way to write off this large expense somewhere to reduce taxable income.

        I’m still pretty confused about it all, I had no idea it would be so complicated to process all this paperwork through the system. It’s been dragging on for months now, but it is getting near to completion finally. I have to sell a couple of properties my mom owned – and I don’t know what basis to use for the (presumed) capital gain on the sale. Since it’s been several months now, would the IRS accept today’s sale price as the basis, or how do I determine what the value of the property was last July? Can an appraiser somehow determine the value of the property as it was over six months ago? If I were to get an appraisal, and sold for less than the appraisal would the IRS allow a loss deduction on that sale based on the appraisal? This is one thing that I am really not clear on, what they will accept for cost basis. Do you have any idea?

        Thanks again, you have been a tremendous help to me and I do appreciate it very much. My attorney is no help at all in these matters, and just tells me to go call an accountant. With what I’m paying him, he should be doing all this for me! If I had known this was so complex when I began, I would have insisted on him including doing the taxes as well, included in his exorbitant fees. Too late now…

      • Rob

        Good to hear from you and thanks for the kind words. I am also glad to hear my thoughts were helpful.

        On the issues of tax returns, I am going to suggest that you contact an Enrolled Agent who is someone who specializes in doing tax returns by going to http://www.naea.org where you can find one close to you.

        All the items you noted about the different income amounts like dividends and gains or losses on sale of property, and attorney fees and tax prep fees all have value for the beneficiaries of the estate once the tax return is prepared and filed. This is not something to take on unless you are a tax preparer or a glutton for punishment.

        While you are correct about income after her death, the various 1099s might not be showing the correct SSN or EIN so these need to be handled correctly.

        On the sale of the property, you need to talk to a real estate appraiser and ask for a valuation as of date of death – this will be the cost basis for the property to use for figuring the gain or loss. The expenses of sale like commissions are used to reduce the gain or increase the loss.

        The estate tax return will reflect all the items that are reportable on the return and will also identify what the net income or loss is that will then be shared with the beneficiaries on a Schedule K-1 that is part of the estate tax return.
        Each beneficiary will receive their own K-1 and that will become part of their tax return. As an example, if the sale of the house showed a loss that loss will then get reflected on the K-1 that you receive as your share of the capital loss that you will then get the benefit of on your return.

        As for whether you need a final tax return for your mother for the period prior to her death, I will leave that up to the tax professional you engage to answer that question. You should be planning on a final tax return for her, a tax return for the period from her date of death to one year after that and maybe a second year’s tax return if it takes you more than one year after her death to resolve all issues with her estate.

        On the RMD issue, remember that you need to take at least the RMD for you every year going forward. If you do not there are penalties for not doing so which I am sure you want to avoid. And make sure you have named beneficiaries on this IRA, both primary and contingent beneficiaries. And remember that you could use this RMD as the source for funding your contribution to your Roth IRA if you have not yet taken care of doing that. You have until April 15, 2014, to fund your Roth IRA for 2013.

        Hope this is what you need, and keep me appraised on how this works out as I would like to be able to see the closure on all these topics.

        Good luck.

  103. An outstanding share! I have just forwarded this onto a colleague who
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  104. Hello, Mr. St.Onge,
    Thank you for all of your valuable advice. I have a 17 y/o son about to start college in Sept. 2014. I only have one child so this is the only time I need to cover a child’s tuition costs. I have a some money saved in various investment vehicles and I’m unclear about the best ways to maximize the money to help pay for college. I’m married & 45 y/o. I file taxes jointly/married. My 2012 AGI was approx. $146,000, which included approx. $30,000 in withdrawals from an IRA-BDA. I earn approx $120,000 and my wife earns approx $6,500. I have a 401k of approx $450,000, but my wife has no pension. Our other savings consists of the previously mentioned IRA-BDA from my deceased dad that has a current balance of approx $50,000. We also have a Traditional spousal IRA of approx. $50,000 (she is 60 so no penalty) and a Roth IRA of approx. $20,000. Unfortunately I neglected my son’s 529 and it only has $3,200 in it. My original thinking was I would take IRA withdrawals to cover tuition costs if my son didn’t get any scholarships. However, I recently realized by taking IRA distributions to cover tuition costs his financial aid formula might affected in his subsequent years for college under FAFSA. I have approx $150,000 – $175,000 in equity in my house available to me for a H/E or HELOC loan. Any suggestions for withdrawal strategies to pay tuition costs is appreciated.

    • Kevin

      Thanks for your comments and I will try to answer your question about the college funding. As you have identified, there are many options open to you – all with different tax consequences based on which option you choose.

      I will concede up front that I am not an expert in the college aid formula arena but I do understand that they look at the various assets you have in different ways. I would suggest you talk with a college aid officer at your son’s high school or at the college you are planning to attend to get their take on your options.

      I will, however, provide you with some thoughts on the various ways you could go with respect to paying the tuition each year. In this arena, I take a longer term view of when and how to pay for tuition which may stretch the way you look at the options I will present.

      I start with the perspective that your invested assets (regardless of which pot they are in) will continue to be invested and grow over the time that your son is in college. As such, if you used student loans while he is in school and then made a decision after he graduates as to how you want to pay off the loans, you might find that you are further ahead versus using the invested assets you have today to pay the next few year’s tuition and fees. This requires some rethinking on your part as it relates to taking on debt when you have assets to pay the tuition now. So let’s keep that in mind as you read the following.

      You should not look at the money in your 401k as being available to pay tuition in any way. If you took a loan from this asset, you would be paying taxes twice in the long run. You would be paying back the loan with after tax money (you already paid taxes on this money) and then you get the honor paying taxes on that money again when you take it out in retirement. Not what you want to do.

      The IRA that your wife has would be subject to being taxed if you used this for tuition and this would not be subject to any penalty as she is over 59 ½, so this might be a source for the tuition. Since this is a traditional IRA, we would need to know if any of this IRA has “cost basis” (the annual contribution that was made) that would not be taxable upon withdrawal. The key to the cost basis question is whether the contribution was deducted on your tax return in the year of the contribution. However, you also need to look at what the tax rate would be on any withdrawal you would make. Based on the information you provided you are currently in the 25% incremental tax bracket where you have at least $40,000 of income that could be added to your return that would be taxed at 25%. So this is a possible source for the tuition. But again not what I would recommend to you.

      Another option would be the IRA you inherited from your dad. As you know you are required to take a minimum distribution from this IRA every year. For 2014 it looks like that would be 2.58% of the value at the end of 2013, or about $1,290. You can take more than that each year so this too could be a source for the tuition.

      On the Roth IRA, if this is your wife’s Roth IRA, the entire amount would be available without any tax issues. If this is your Roth IRA, then only the amount that has been contributed can be taken out with no tax issues. The earnings part is not available to you until you reach age 59 ½ without penalties and taxes on that amount. If you used this asset you would be removing a tax free growth asset from your portfolio which is not a good idea in my mind.

      The Home equity loan route would be a possible source that would be based on a few factors. For instance, if you are able to use Schedule A to itemize deductions and this mortgage interest would be beneficial to you then this would be a viable alternative to consider. The other major factor would be whether tapping into your home equity is something that you can manage as you would be putting your home at risk if you were to be unable to meet the payments on the loan in the future.

      Getting back to using student loans as the source, the key issues here are that the interest paid on the loans provides a small tax deduction for the person reporting this interest on their tax returns when the repayment period starts, which is usually six months after the student finishes attending college. This might be five or six years down the road. In the meantime, your investments are continuing to grow for those 5 or 6 years. How much they grow is not known because no one knows what the future brings in this area but we should be optimistic that the returns will be positive over such a long period of time. What is more important is what type of investor have you been and will be going forward. This will impact how much the investment portfolios grow in the interim.

      There were a few items that you did not include in your comments that would be helpful in determining what action to take. First is how much will the tuition be per year. You may not know this because your son may not have selected a college as yet, but it has a huge imact on what options you will really need to use. Second, how much is he going to be contributing from his working. I would expect that he would be or certainly should be as a condition of getting help from you to pay for his college. Third, you mentioned having withdrawn $30,000 from your inherited IRA but did not provide any reason for that withdrawal. This is a concern from the perspective of what else is involved in your life that would impact where the tuition money should come from. These issues would impact what my recommendation would be once I knew all these facts.

      You have done a great job in putting money into your 401k but I am not seeing any money going into a Roth IRA for you or your wife. This is an area where you may want to refocus where you are saving money going forward. I would be seriously recommending this refocus if I were providing financial planning services to you and your wife.

      I would suggest that you use the “Find a Planner” part of this blog site near the top right hand side of this article to find a fee-only planner near you who could help with the issues I have identified as well as any other issues that may surface from that discussion.

      I hope this has been helpful to you. If you have any other comments that you want to leave, feel free to do so and I will respond to them. Good luck to your son as he pursues his future.

  105. Thank you for all the information. It has been very helpful. I figured the least beneficial option was dipping into my investments so thank you for confirming that for me. I just wanted confirmation that taking some type of loan was a sensible, if not preferred strategy. I’m financially responsible enough to handle a HE / HELOC loan. As far as some of your questions go: I’m not sure of the cost basis of my wife’s IRA since it was carried over from her previous marriage, which was her only asset from that marriage so no other retirement options like a partial pension from her ex, etc. I will try to research that with her previous brokerage house. The Roth is mine so I would have a penalty on the earnings portion. I don’t know about tuition costs yet as he is still waiting to hear from all the colleges on acceptance and if they are offering any financial assistance. Of the colleges he has been accepted it looks like the tuition costs will be in the $20-$30k range depending on school. He’s been offered packages from the schools but their tuition ranges from $42k – $60k per year so that is why the costs are so high. My son will be responsible for $5k – $10k per year, depending on what the overall tuition costs are. The $30k from the IRA-BDA was partially related to a home repair, about $15k, and also some money was used for one-time expenses. Lastly, I agree my IRAs have suffered. The strategy I used with my 401k was it seemed to be growing and I took the approach that if I continued to put the bulk of my investment savings into the 401k it would grow faster. So in a sense I put all my eggs in one basket. In my defense my 401k is essentially a large cap index fund that is closely tied to the S&P very similar to the Vanguard VFINX large cap fund, so I felt even though I wasn’t diversifying my investments as a group, I took comfort in the fact that my 401k was diverse. None of it is tied towny type of employer stock situations. My average rates of return despite some ups downs over the last 15 years have been about 9-10% so I kept dumping my funds into it. Thank you again for everything.

    • Kevin

      Thanks for your follow-up and I am glad to hear the information was helpful.

      A suggestion on your son’s educational pursuits related to the cost side. He might want to look for a local college for the first year or so of courses where the cost would be lower while he takes the required courses that may not be related to what he plans to major in when he finishes school. He would just need to be sure that the courses he takes would transfer to the place he wants to go to for the degree.

      On your 401k, you should look at more diversification than what you have if all you are using is an index related to the S&P 500. You have exposure to a very narrow slice of the overall equity market and maybe no exposure to the bond market. If you started using some of what you are currently saving in the 401k to put into the Roth IRA you would be able to avoid the future taxes on the growth that would occur in the Roth IRA. Of course be sure to put enough into the 401k to get all the match your employer is providing but any excess to that amount would be better in a Roth IRA for you and your wife based on your earnings.

      I would again encourage you to contact a fee-only planner using the “Find a Planner” tab at the top of this page. You should be able to pay by the hour to get the time needed of a professional review of your situation, including figuring out all the issues you should consider addressing.

  106. I have been seeking advice since my grandmother’s passing this past June. I am the executor of her estate and she left an IRA to my son who is 7 years old. When I contacted the IRA company they told me that they cannot pay out to the minor since it is over $10,000 and that I needed to get a guardianship of property from the court in order to claim it for him. As executor of the estate and parent of this child, shouldn’t I be able to be custodian of the IRA and distribute it to his 529?

    • Confused Mom

      Thanks for your comments, I am sorry to hear of the passing of your Grandmother.

      The IRA company is essentially correct in what they have told you. You are merely the executor and custodian but that does not give you the freedom to do whatever unless it fits with the rules (law) of the issues you are trying to address.

      As executor of the estate, your purpose is to deal with assets that have not been already designated for distribution, like the inherited IRA that has beneficiaried to your son.

      Since your son is not of legal age, he is not able to receive certain assets, like the IRA, unless there is a guardian or custodian who is an adult. In these cases that probably requires a court appointment in your state (a lawyer would be able to advise you on the process required). If you are appointed guardian, then you are the protector of these assets for your son and his benefit until he reaches majority age of 18 in most states. This means you have to use these assets for his benefit and follow the distribution rules of an inherited IRA. In this case, the rules provide that he needs to have 1.32% initially withdrawn (Required Minimum Withdrawal – RMD) for a 7 year old and this percentage goes up each year as he gets older. You can take out more in any year but not less. The first distribution needs to be taken this year.

      What needs to be recognized is that any withdrawal is income subject to federal and state taxes. If the IRA was worth $10,000, the withdrawal would be only $132 which would not create a tax if that was the only income for your son. If you took the entire $10,000 out in one year, there would be taxes on some amount. Would you have acted prudently if your son incurred a tax on a portion of the IRA? That is a question for the courts.

      As to using this money to increase the amount in your son’s 529 plan, the issues of prudent actions also applies. Assume that when your son becomes age 18 and he does not need this money for college for any number of reasons. If he took this money out for non-education reasons, the rules would provide for taxes and a penalty on the amount used for non-education. Would that mean you acted prudently today in your son’s interests? Again, a question for the courts.

      You may want to discuss with an attorney whether as executor you can have a custodian appointed for your son’s IRA which might be done without going to court for the guardian appointment.

      Let’s look at the issue you raised about taking the money out of the IRA and putting it into a 529 plan. If left in the IRA this money could be invested in the same type of investments that you would be able to do in the 529 plan, so either method would result in the future value of the investment to be the same except for the RMDs taken out each year from the IRA. So at age 18 your son would be able to decide what he wants to do with each asset. The IRA would allow him to continue to take the RMD or a larger amount each year, report and pay whatever tax is due and use the remainder to pay for his tuition. If planned properly, he would not be paying any income tax on the amount withdrawn at that time. If the money was put into the 529 plan today at age 18 he is only allowed to use it for education on a tax-free basis, any other use would be subject to tax and penalty. If your son were to earn a full scholarship to college he would not have a need for the 529 money for education so he would have a dilemma facing him.

      My vote is to get the custodian or guardian appointment in place, take the RMD each year so your son has some fun money to remember Great-Grandma by (maybe take the RMD out on her birthday each year) and let the IRA continue to grow for the rest of his childhood. He may decide he wants to remember his Great-Grandma for the rest of his life – what a nice legacy – and continue the RMDs as an adult. Finally, be sure to name a new beneficiary for this inherited IRA and I would also name a contingent beneficiary to get more flexibility in the future as to who would be able to get the balance of this inherited IRA upon your son’s demise.

      I hope I have provided you with the information you need to be able to move forward on this issue. If you have any further questions, feel free to leave another comment.

  107. Hi,
    My husband is inheriting an IRA, along with his sister, from his father that consists mainly of variable annuities. We know we want to keep the IRA and make RMD’s based on the life expectancy of my husband who is 51. We would like to transfer it to another trustee such as Vanguard. We would also like to get rid of the annuities and invest in other things. How are annuities split between two beneficiaries? Can the beneficiary IRA be transferred to another Trustee such as Vanguard and then the annuities sold and new investments bought? My father in law was 77 and had taken regular RMD’s. The annuities had not been annuitized. We are looking for the best way to get out of the annuities and into better investments for ourselves and transfer the IRA to another trustee. Any advice would be appreciated.

    • Dawn

      Thanks for your questions about the IRA issues and my condolences to your family on the loss of a loved one.

      The answer to the annuity questions will reside in the details on the fees to be charged for withdrawals. In many annuities there is a maximum that can be withdrawn each year (like 10%) without any charge or penalty which effectively locks up the annuity from being cashed in all at once. So you need to check on the details of the charges when you want to take out more than that amount.

      These charges may be there if you want to move the entire amount to a new location like Vanguard so be sure to check this out before making any decisions. I would ask Vanguard or wherever else you want to move the assets if they would let you move it as an annuity. My guess is the answer is no, you need to bring it in as cash which effectively requires you to withdraw the entire amount and incur whatever fees/penalties the annuity holder wants to charge.

      I would also use this as an opportunity to review your entire investment portfolio to see how this annuity fits in as part of a balanced and diversified portfolio. For instance, you could look at the annuity as the fixed income portion of your portfolio which would allow you to be more into the equity and other type holdings for the balance of your investments.

      Being a variable annuity, the underlying investments would probably be a series of mutual funds that the current trustee makes available to the annuity holder. This means you have some control over what these assets are invested in going forward. As for the splitting of the annuity between the two heirs, the trustee would create two new inherited IRAs for each heir. They would probably allocate the underlying assets between the two heirs but then each heir would have the opportunity to change what the assets are invested in. Keep in mind that you need to check what happens on the fee side for these various changes. I have seen situations where the trustee uses this time of change to also change what the interest rate might be on an annuity resulting in the new annuity having a much lower interest rate.

      I would suggest that you go to the ”Find a Planner” tab at the top of this page to find a fee-only planner near you who can assist you with the technical side of these issues. This planner could also help in sorting out how this annuity can be part of your overall financial plan.

      Be sure to name new beneficiaries for these inherited IRAs including contingent beneficiaries to provide greater flexibility upon the passing of each of these heirs. Also be aware that this inherited IRA cannot be converted to a Roth IRA but the amount you have to take out each year can certainly be used as the source of the contribution to a Roth IRA assuming that your husband has earned income each year.

      I hope this is the information you need. If you have additional questions, feel free to leave another comment.

      Frank

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