Lynn Brenner's Family Finance

Don't Make Your Estate Your IRA Beneficiary

Q: My mother had an IRA and the IRA beneficiary is her estate.  However, her will leaves everything, including the IRA, equally divided between my sister and me.  Since we were not the actual beneficiaries on the IRA, what is our best course of action to reduce tax exposure?  I’ve seen a lot of documentation on how to handle an IRA if you are the beneficiary, but since the estate is the beneficiary, the attorney handling her will says it makes a difference to us. -- CS via email


A:   Your lawyer is right. The rules are different when the estate is the IRA beneficiary.

In fact, there are three sets of rules for inherited IRAs. The first applies only to beneficiaries who are surviving spouses. The second applies to all non-spouse human beneficiaries -- i.e., children, siblings, friends. And the third applies to non-human beneficiaries like estates and charitable organizations.

A surviving spouse can transfer an inherited IRA into an IRA in his or her own name, and thus postpone taking taxable distributions from the account until after turning 70 and a half.

But no other heir can transfer your IRA into a new account in his or her own name. They must start taking distributions after your death. The big question is, how fast must they empty the account? A lot of money rides on the answer, since the longer they can postpone taking money out of the IRA, the longer it can keep growing untaxed.

If the designated IRA beneficiaries are human beings, they can take minimum annual distributions based on their own life expectancies. But in your case, the IRA beneficiary is your mother's estate -- and it has no life expectancy. The result: 

If your mother was under 70 and a half when she died, her IRA must be emptied within five years of her death. If she was older -- and therefore already taking mandatory IRA distributions -- you and your sister can empty the account over her remaining life expectancy, as defined on the Internal Revenue Service 'Single Life' actuarial table for IRA owners. You'll find that table in the index of IRS Publication 590, which you can download at www.irs.gov.

Please send your questions to Lynn@LynnBrennersFamilyFinance.com.  I'm sorry I can't respond personally to every email. Questions are only addressed online.(c) Lynn Brenner, All Rights Reserved

    

After I Inherit a Roth IRA, Will I Owe Income Taxes on Its Future Earnings?

Q: If I inherit a Roth IRA from someone I'm not married to, will that IRA's future investment gains be tax-free -- that is, if I leave the money in the account? --MA via email

A: The Roth IRA's investment earnings will continue to be tax-free. But you won't be able to leave all the money in the account.

This is the main difference between being the owner of a Roth IRA and being the account's beneficiary. An owner never has to take any distributions from a Roth IRA, regardless of his age. A non-spouse beneficiary must take minimum annual distributions based on his or her life expectancy. (Someone who inherits a spouse's Roth IRA can become its owner, by transferring the inherited account into a new Roth IRA in his or her own name. )

The annual distributions you must take from the Roth IRA are tax-free -- but don't underestimate their importance! 

The penalty for failing to take them is 50% of the amount you should have withdrawn, but didn't.

If your minimum annual distribution was $2,000, for example, but you took nothing out of the account, the penalty would be $1,000.

The good news is that because the balance in the account keeps growing untaxed, an inherited Roth IRA can grow into a much bigger nest egg if you can afford to take no more than the minimum required distributions while you're still working.

If you inherit a $150,000 Roth IRA at age 45, for example, your first required annual distribution will be $3,866 ($150,000 divided by your 38.8 year life expectancy). If you take only minimum distributions and earn an average 7% annual return, the account will have doubled in size by the time you're 65.

Please send your questions to Lynn@LynnBrennersFamilyFinance.com.  I'm sorry I can't respond personally to every email. Questions are only addressed online.(c) Lynn Brenner, All Rights Reserved

How Soon Should a Widow Transfer Her Late Husband's IRA into Her Own Name?

Q: I am a Certified Financial Planner in the Midwest. One of my clients has inherited her late husband's IRA. A certain large mutual fund company has told her to move her deceased husband's IRA into an inherited/beneficiary IRA. She's been told that later on, if she wants to, she can later move it into an IRA in her own name.  He was 62 when he died. She is 57 years old, and has more than enough money to carry her to age 59 1/2. 

But the real question is, can you move an inherited/beneficiary IRA from your spouse into an IRA in your own name down the road -- or is the decision to keep it as a beneficiary IRA irrevocable? -- MA via email

A: Some IRA decisions are indeed irrevocable, but not this one. Your client won't lose her option to transfer her late husband's account into a new IRA in her own name at a future date.

For readers who don't know, when you inherit an IRA from your husband or wife, you have a choice: You can keep the IRA in its original owner's name, and continue to be the beneficiary. Or you can transfer it into a new IRA in your own name, and become the new owner.

What if Mary decides to keep the IRA in John's name? Then as the beneficiary, she must start taking distributions from the account by December 31 of the year John would have turned 70 and a half, or by December 31 of the year after his death, whichever comes later.

If she transfers it into an IRA in her own name instead, she won't have to take distributions until after she herself turns 70 and a half. But if she does take a distribution before she turns 59 and a half, she'll owe a 10% early withdrawal penalty on the amount she withdraws.

In your client's case, if  she keeps the IRA as a beneficiary account, she doesn't have to take any distributions for another eight years, since her husband was 62 when he died. But if she does take one -- she has plenty of money, but who knows what unexpected need might arise -- she won't owe an early withdrawal penalty on it. There are no early withdrawal penalties on a beneficiary IRA.

Your client will be able to move the beneficiary IRA into an IRA in her own name later on, says Barry C. Picker, a Brooklyn NY tax accountant and IRA expert. Indeed, she should do that before the eight years are up, or she'll have to take annual distributions whether or not she needs them.

But in the meantime, he adds, she must be sure to name a successor beneficiary on her beneficiary account. Let's say her son -- we'll call him Kevin -- is the successor. If Mary is hit by a truck at age 63, her successor Kevin will be able to empty the IRA over his own life expectancy. **

If she doesn't named a successor beneficiary, and dies before she transfers the beneficiary IRA into an IRA in her own name, the account will have to be paid out within five years of her death, says Picker.

**An earlier version of this post incorrectly said Kevin would have to empty the IRA over Mary's remaining life expectancy. If you want to know the details, please email me. If not, be thankful that you don't need to know anything more about these arcane rules!

Please send your questions to Lynn@LynnBrennersFamilyFinance.com.  I'm sorry I can't respond personally to every email. Questions are only addressed online.(c) Lynn Brenner, All Rights Reserved

Can I Combine Inherited Roth IRAs with an Inherited Regular IRA in a Single Account?

Q: My husband recently passed away, and I am the beneficiary of his four Individual Retirement Accounts and a 403(b) account.

I want to transfer the 403(b) into my own 403(b) account.

Three of the IRAs are Roth accounts, and one is a rollover IRA. I was hoping to move all of the IRAs into one account to take advantage of compounding. I assume the best way to do this is to have athe IRAs transferred directly from one custodian to another

Can the Roth IRAs and the rollover IRA be combined in a new account? -- LS, via email

A: No, no!

(The extra no! is because even if you could legally combine them in one account, you wouldn't want to.)

Let's start by pointing out that you are the surviving spouse of the person who originally owned these retirement accounts. That's important because it gives you more options and more flexibility than any other beneficiary.

In other words, non-spouse beneficiaries shouldn't use this post as a guide!

Your 403(b) question first, since it's simpler. The law now allows you to transfer money from one 403(b) plan into another. However, no 403(b) plan is required to accept transfers. Find out what your plan's rules are. If it accepts transfers, the best way to do this is by arranging for your late husband's plan to switch his account directly to your own plan.

Okay, what about the IRAs?

For those who don't remember the rollover IRA, it's a traditional IRA that contains only money transferred from an employer-sponsored retirement plan like a 401(k). By keeping this money segregated as a 'rollover' IRA, you preserved the option to transfer it back into another 401(k) plan at some future date.

Rollover IRAs are no longer necessary, because the law has been changed to permit you to transfer IRAs into a 401(k) plan even if those IRAs weren't originally created with 401(k) plan contributions.

Okay -- you've inherited three Roth IRAs and one traditional IRA. Roth IRAs and traditional IRAs can't be combined because they are taxed very differently.

Your withdrawals from a Roth IRA are tax-free. Your withdrawals from the traditional IRA are taxable. Even if the law allowed you to combine them, it would be foolish to mix a tax-free account with a tax-deferred account. (It's a real headache to take withdrawals from an account that's part tax-free and part tax-deferred. Just ask anyone who's taking money from a traditional IRA that includes both pre-tax and post-tax contributions!)

You can combine the three inherited Roth IRAs into a single Roth IRA in your name. And you can put the rollover IRA into a new traditional IRA account in your own name. And yes, a trustee-to-trustee transfer is always the best way to move IRA money.

Once the traditional IRA is in your name, you can convert it into a Roth IRA, if you wish -- but there's a price tag.  Money you move from a traditional IRA to a Roth IRA is taxable; so if you convert $50,000 into a Roth IRA, you'll owe income taxes on $50,000.

In exchange, you get an account that is tax-free going forward: After you've owned the new Roth IRA for at least five years AND you're 50 and a half or older, all your withdrawals are tax-free. What's more, you never have to take Roth withdrawals if you don't want to. You can let the account keep growing tax-free and leave it to your kids.

By contrast, if you keep this money in a traditional IRA, you will have to start taking withdrawals after you're 70 and a half; and they will be taxable.

And here's a tip from IRA expert Barry C. Picker: If you decide to do a conversion, keep the new converted Roth IRA separate from your existing Roth IRA -- the one you created from the three inherited Roth IRAs -- until after October 15 of the year following the conversion.

The reason: If you change your mind about the conversion, you have until October 15 of the following year to undo it and turn your new Roth IRA back into a traditional IRA. (And yes, if you've already paid the tax on the conversion, you get a refund.) If you keep the converted Roth separate, it's easy to undo the conversion. You can still undo the conversion if you add it to an existing Roth account, but it won't be as simple. You'll have to calculate the appropriate amount to return to the traditional IRA. If you converted to a brand new Roth IRA, you can just move the entire account back.

Please send your questions to Lynn@LynnBrennersFamilyFinance.com.  I'm sorry I can't respond personally to every email. Questions are only addressed online.

(c) Lynn Brenner, All Rights Reserved