Lynn Brenner's Family Finance

What Happens if You Inherit an IRA from a Trust and the Previous Owner Didn't Take His Last Annual Distribution?

Q: My father passed away in July, leaving an IRA in trust that is to be divided amongst the three children.  We intend to divide the inherited IRA (carefully), and we know we will have to take mandatory distributions starting on December 31, 2011.

My father was over the age of 71 when he died, and had not yet taken his mandatory distribution for this year (2010).  My question is:  Do we need to take a mandatory distribution from the undivided IRA this year in the amount my father would have had to take? Or do we ignore the distribution this year and start our mandatory distributions individually next year? --SK via email

A: It's never a good idea to ignore a required IRA distribution!

After you turn 70 and a half, you must take a yearly minimum distribution from your IRA, and the year of your death is no exception. If you die before taking your required minimum distribution, your heirs must take it for you.

You say your father was over 71 when he died. Assuming he turned 70 and a half in 2009, he did indeed have to take a minimum 2010 IRA distribution.

Your deadline for taking his 2010 distribution for him is this December 31. To calculate the correct amount for that distribution, use the Uniform Table for Determining Lifetime Distributions. It's at the back of IRS Publication 529, which you can download here.

That actuarial table is only for IRA owners. To calculate your own required distributions, you and your siblings should use the Single Life Expectancy Table For Inherited IRAs, which you'll find in the same publication. As you say, your deadline for taking your distributions is December 31, 2011 -- the end of the year after your father's death.

Your father left the IRA to a trust to be divided between his three children. Assuming the wording of the trust allows it, each of you can take his or her share as an Inherited IRA -- but all three of you must use the life expectancy of the oldest to determine your required distributions, says Barry C. Picker, a Brooklyn tax accountant and IRA expert. (Other IRA owners, take note: That's one of the drawbacks of leaving an IRA to a trust for several beneficiaries. They can't each base required distributions on their own life expectancies.)

To determine the correct amount, divide your share on December 31 of the previous year -- i.e., 2010 -- by the life expectancy factor on the IRS table.

If the oldest will be 49 in 2011, for example, his life expectancy factor is 35.1. 

If your share of the IRA is $25,000 on December 31 2010, your minimum annual withdrawal in 2011  would be $712.25 -- $25,000 divided by 35.1. Every year, your withdrawal will be based on the account balance at the end of the previous year; and every year, you'll reduce the original life expectancy factor by 1. (In 2012, your life expectancy factor will be 34.1; in 2013, it will be 33.1, etc.)

Of course, you can always take out more than the minimum. And as an IRA beneficiary, you don't own an early withdrawal penalty on distributions regardless of your age.

Please send your questions to [email protected].  I'm sorry I can't respond personally to every email. Questions are only addressed online.

(c) Lynn Brenner, All Rights Reserved

At What Age Can I Move My IRA Penalty-Free From One Bank to Another?

Q: I have traditional and Roth IRAs of my own, and I have also inherited some traditional IRAs. I am currently taking annual distributions from the inherited IRAs based upon my own life expectancy. Here are my questions: 

When I reach age 59 1/2, I understand that I can "move around" all IRAs (traditional, Roth, and Inherited) without any penalty. Is that correct? Is there any special treatment for moving Inherited IRAs from one bank to another? Now that bank interest rates are slowly creeping up, after I turn 59 and a half I'd like to move some IRAs that are invested in CDs currently earning low interest rates. Are there any tax consequences if I do this? Will I have to file anything with the IRS when I move an IRA from one bank to another?

If I have four IRAs in four different banks, is there any rule against moving all of them in the same year?  Is there a limit on the number of times I can move each IRA in one calendar year?

Are there any penalties in "breaking" any of the IRA CDs before their maturity dates?

At what age can I take out some of my own IRA money without penalty? I know that any money I take from the traditional IRAs have to be reported on my tax returns. But am I right that I don't have to report my withdrawals from the Roth IRAs? --DM, via email

A: You don’t have to wait until you’re 59 and a half years old to move the IRAs you own from one provider to another without triggering any taxes or any tax penalty. An IRA owner can do that at any age.

It's not always possible for a beneficiary to move Inherited IRAs, however, as I’ll explain in a moment.

But even though there is no tax penalty, you may trigger a provider's early withdrawal penalty depending on how your IRA is invested.  A prime example is moving a CD before its maturity date. The only time banks waive this penalty -- and not all of them do -- is if you must ‘break’ a CD before maturity in order to take a required distribution from an IRA after you turn 70 and a half years old. 

You don’t have to file anything with the IRS when you transfer an IRA between providers. And there’s no limit to how many times you can move each IRA in a single calendar year – although moving four IRAs several times a year would require a high tolerance for filling out financial services providers’ paperwork.

The best way to move an IRA from one provider to another is in a trustee-to-trustee transfer: You want to move an IRA from Bank A to Bank B. You open a new IRA at Bank B, and then Bank B asks Bank A to transfer your IRA money into the new account.

Alternatively, you can take a check from Bank A and deposit it in a new IRA in Bank B. But in that case, to avoid taxes you must deposit the entire amount in a new IRA within 60 days. (This is called the 60-day rule.)

You can start withdrawing money from your own traditional IRAs without incurring a 10% early withdrawal tax penalty as soon as you turn 59 and a half. But the amount you withdraw is taxable income. (The IRA custodian reports IRA withdrawals to the IRS – so don’t omit it from your tax return in the hope that you can avoid paying taxes on it.)

Your Roth IRA withdrawals are all tax free after you turn 59 and a half and have owned the account for five years. You don't have to report them to the IRS.

Okay, so what about moving an Inherited IRA from one bank to another?

The IRS has no objection to your doing this, as long as you put the new Inherited IRA account in its original owner's name, listing yourself as the beneficiary. But occasionally, the bank’s rules don’t allow IRA beneficiaries to do a trustee-to-trustee transfer; this doesn't happen often, but it does happen. Unlike an IRA owner, an IRA beneficiary cannot use the 60-day rule to avoid taxes on a transfer. In other words, by refusing to allow trustee-to-trustee transfers, a bank with this rule makes it impossible for a beneficiary to move an Inherited IRA without triggering taxes.

Please send your questions to [email protected].  I'm sorry I can't respond personally to every email. Questions are only addressed online.

(c) Lynn Brenner, All Rights Reserved

 

Retirement Plan Rules Say I Must Withdraw My Account at 70 and a half. Will I Have to Pay Taxes on It?

Q: I'm a 68 year-old with zero tax deductions who is still working. I'm maxing out on my contributions to my Thrift Savings Plan retirement account, plus doing my over 55 catch-up contribution to reduce my taxable income. I'm considering withdrawing about $60,000 from my account to pay off my mortgage. I owe about $26,000 on the house at 6.75%. I'd convert the rest into my Roth IRA. I do have funds to pay the taxes on this withdrawal.

I have two questions. First, what's the most I could withdraw without going into a higher tax bracket? Second, I've heard that if you take a withdrawal while still working, when you do retire and turn 70 and a half, you must withdraw the whole account. That would mean a big tax bill. If this is true, is there a way around it? --RC, via email

 

A: You should take the first question to your tax accountant. Even a tax professional can't tell you how much you can withdraw without being bumped into a higher tax bracket without more information about your situation.

But you don't have to worry about the second question. You won't be hit with a big tax bill at 70 and a half.

Let's make things clear to other readers by explaining that the Thrift Savings Plan (TSP) is the defined contribution plan for federal government employees. In many respects, it resembles a 401(k) plan -- but not in all respects.

For example, 401(k) plans only permit pre-retirement withdrawals under very specific conditions of financial hardship. By contrast, the TSP allows its participants to do a one-time pre-retirement transfer of money to an IRA after turning 59 and a half.

This is called an 'in-service age-based withdrawal'. That's what will let you withdraw $60,000 from your account. (To comply with the rule, you'll probably have to transfer the entire $60,000 to the Roth IRA, and then use $26,000 to pay off the mortgage.)

The same TSP rule that permits this type of pre-retirement withdrawal says that if you use it, you must take the rest of your money when you retire.

But that doesn't mean you'll have to pay taxes on the entire amount. All you need to do to preserve its tax-deferred status when you retire is transfer it from the TSP into a traditional IRA.

By April 1 of the year after you turn 70 and a half, you must start taking minimum annual withdrawals from your tax-deferred retirement accounts. (This is true whether your money is in the TSP, a 401(k), or a traditional IRA). But only the amount you withdraw is taxable. The balance remains tax-deferred.

You're never required to take withdrawals from your Roth IRA; but any withdrawals you do take are tax-free after you're 59 and a half and have owned the account for five years. The five year clock starts on January 1 of the year you open your first Roth IRA, and that date applies to all your subsequent Roth IRA contributions to that account, as well as to Roth IRA accounts you open later. (As far as the Internal Revenue Service is concerned, you have only one Roth IRA, no matter how many accounts it's divided in.)

Your $60,000 withdrawal will be subject to income taxes since you're not going to transfer it into a traditional IRA. Even so, using this money to pay off the mortgage can make financial sense:

You say you have zero tax deductions. In other words, you aren't deducting the 6.75% interest you're paying on the mortgage. (Your mortgage is almost paid off, which means the interest portion of your payment is very small. The interest is probably less than your standard income tax deduction, says Barry C. Picker, a Brooklyn NY tax accountant.)

Since you aren't getting a deduction for that interest, using $26,000 to pay off the mortgage is like investing the money at a risk-free 6.75%. You can't beat that these days!

One suggestion: Convert the withdrawal into a new Roth IRA. Don't put this money in an existing Roth IRA. Here's why:

If you do a Roth IRA conversion in 2010, you have until October 15 2011 to change your mind and move some or all of the converted amount back into the tax-deferred retirement account it came from. (This is called 'recharacterizing' the conversion.)  It's much, much simpler to do this if you haven't commingled the converted money with an existing Roth IRA.

After the recharacterization deadline has passed, you can always consolidate your Roth IRAs if you wish. Even if you don't, the five year clock that started with your first Roth IRA will apply to the new one too.

Please send your questions to [email protected].  I'm sorry I can't respond personally to every email. Questions are only addressed online.

(c) Lynn Brenner, All Rights Reserved

 

 

If I Take Money from an Inherited IRA, Will I Owe an Early Withdrawal Penalty?

Q: I'm the beneficiary of a deceased IRA owner. I'm 56 years old. If I move this IRA to another company, can I take early withdrawals without paying a penalty? (I know I'll have to pay income taxes.)

Also, what would be the name of the new IRA? -- MA, via email

 

A: As an IRA beneficiary, you never owe an early withdrawal penalty, regardless of your age. You're right that you'll owe income taxes on the withdrawals, but they'lll be penalty-free.

In fact, there's a penalty if you don't take withdrawals from this account.

When you inherit an IRA, you must start taking minimum annual withdrawals based on your own life expectancy, unless you're the widow or the widower of the account's original owner. (Surviving spouses have alternatives, as I'll explain in a moment.) The deadline for the first required withdrawal is December 31 of the year after the original owner's death.

The IRA must remain in its original owner's name, but you can add your name to the account as its beneficiary.

For example, let's say the IRA belonged to Irwin Green, who died last June, and you are Marvin Rumplemayer. In that case, the IRA should be titled:

'Irwin Green IRA (deceased June 20, 2009) for the benefit of Marvin Rumplemayer.'

A word of warning about moving the IRA to a new company:

Don't take a check that's made out to you! If you do, the whole amount will be taxable. The IRA should be moved in a trustee-to-trustee transfer between the two institutions. If you take the money yourself, you'll trigger income taxes on the entire account.

Usually, a trustee-to-trustee transfer is a routine matter, and you won't have any problem. But occasionally, a custodian won't allow IRA beneficiaries to do trustee-to-trustee transfers. In other words, you can't move that inherited IRA without incurring a big tax bill. They're holding you prisoner.

This is a heads-up for other readers! An IRA owner can always do a trustee-to-trustee transfer. Make sure your IRA custodian gives the same freedom to beneficiaries. If not, move your IRA to one that does.

Okay, what about IRAs inherited by surviving spouses?

If Mary inherits her husband John's IRA, she has a choice: She can keep the account in his name and remain a beneficiary, or she can transfer it into a new IRA in her own name.

If she remains on his IRA as the beneficiary, she doesn't have to start taking minimum distributions until December 31 of the year after John's death or the year in which John would have turned 70 and a half, whichever comes later.

And if she chooses to transfer it into an IRA in her own name, she can postpone taking minimum annual distributions until she turns 70 and a half.

But after she puts the IRA in her own name, she will owe an early withdrawal penalty on money she takes out before she turns 59 and a half. Depending on Mary's financial situation and age, she might opt to keep the IRA in John's name and take penalty-free withdrawals, at least temporarily. (For more about that, see my earlier post, 'How Soon Should a Widow Transfer an Inherited IRA into Her Own Name?')

Please send your questions to [email protected].  I'm sorry I can't respond personally to every email. Questions are only addressed online.

(c) Lynn Brenner, All Rights Reserved