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Winter 2021  Volume 14, Number 4        

IRA paperwork

Errors to Avoid If You Inherit an IRA

A recent private letter ruling by the Internal Revenue Service (IRS) highlights the possible mistakes a beneficiary can make after they inherit an Individual Retirement Account (IRA).

In June of 2021, the IRS ruled in favor of enforcing the basic IRS tax rule for inherited retirement accounts. The rule prohibits a non-spouse beneficiary from doing a rollover. In the case in question, the husband had an IRA and the wife inherited it after he died. The wife named a trust as her IRA beneficiary and named her children as both trustees and beneficiaries of the trust. They inherited the IRA after she died.

The problems started when the children decided they didn’t like the investments in the IRA and wanted to trade stocks with their inherited IRA funds. Since the existing account could not accommodate stock trades, they moved almost all of the inherited IRA assets to a nonqualified brokerage account. The error resulted in a distribution of the inherited IRA assets and the IRA then became fully taxable. They lost a lot of money.

The children requested this private letter ruling from the IRS to reverse the transaction and allow them to move the assets back into a trust-owned inherited IRA and eliminate any tax owed on the distribution. Their request was denied.

While it can be comforting to inherit an IRA, it’s not as simple as it sounds. As this example illustrates, it’s important to work with a qualified advisor who can help you preserve the retirement savings. This is because there are different options for what to do with the assets depending on your relationship to the deceased. A mistake can inadvertently trigger a big tax bill.

Here are the five most common non spouse IRA beneficiary errors:

Rolling Over an IRA Incorrectly

This rule is the same as the example above and it cannot be overstated that a non-spouse beneficiary cannot do an indirect rollover. An. indirect rollover is when the inherited IRA funds are withdrawn and returned to another IRA within 60 days of receipt. While an IRA owner can do this and a spouse who inherits an IRA can do this, a non-spouse beneficiary cannot.

The only option available to non-spouse IRA beneficiary ‐ besides leaving the funds where they are — is to do a direct transfer to a properly titled inherited IRA, also referred to as a trustee-to-trustee transfer.

Again, if the inherited IRA funds are withdrawn, they are taxable.

No Proper Account Title

Before the account holder dies, check to insure that their name appears in the account title. In addition, the IRA must show who inherits or is the beneficiary of the IRA. For example: “Jane Smith (Deceased 1/1/2021), IRA, FBO Tim Smith, beneficiary.” This might sound like standard practice, but some institutions do not do account titling. Instead, they record it in their internal records as an inherited IRA and that can lead to confusion. If the account only has the beneficiary’s name, and not the deceased’s name too, the beneficiary may treat the IRA as their own, which will nullify the inherited IRA. The account would be distributed and the funds taxed (to the extent of pre-tax funds).

Making Contributions to an Inherited IRA

As tempting as it might be, do not make contributions to an inherited IRA. Once a contribution is made to the inherited IRA, the IRS treats it as the beneficiary’s own IRA and the entire account must be distributed and becomes taxable.

Not Taking Required Minimum Distributions

According to the SECURE Act, which was signed into law at the end of 2019, if your 70th birthday is July 1, 2019 or later, you do not have to take withdrawals until you reach age 72. This rule DOES NOT apply to an inherited IRA or inherited Roth IRA. Distributions generally begin in the year after the IRA owner’s death.

Not Realizing Stretch IRAs are a Thing of the Past

The stretch IRA was an estate planning strategy that would stretch IRA distributions and tax benefits over several generations. Beneficiaries could take required minimum distributions based on their own age. This was great for grandchildren and great-grandchildren because the accounts could grow over most of their lifetime. However, with the signing of the Setting Every Community Up for Retirement Enhancement Act (SECURE Act) in 2019, the ability to have and use a stretch IRA ended.

Instead, the heir must withdraw the entire IRA inheritance within 10 years of the death of the original account holder — no matter their age. Money that is distributed from a traditional IRA will be taxable at the recipient’s current income tax rate; but money distributed from a Roth IRA won’t be taxed.


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In this issue:

This Just In...

How to Avoid Challenges to Your Disability Claim

Planning for Care When You Need It Most

Errors to Avoid If You Inherit an IRA

Life Insurance for the One Who Makes a House a Home


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