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Slott Report Mailbag: I Just Inherited an IRA or Roth IRA From My Spouse. What Do I Do Now?

This week's Slott Report Mailbag answers what we call some of the "nuts and bolts" of IRA planning. We received questions on required minimum distributions (RMDs) and inherited IRAs - two of our most popular topics, and also two of the topics where we see the most mistakes and disaster stories. Away we go with another Thursday mailbag! As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure. Find one in your area at this link.

1.

I forgot to take a required distribution or all of my required distribution or the company did not process my required distribution on time. What do I do now?

Answer:

ed slott IRA, tax, retirement planning questions
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A missed distribution, even if it isn’t your fault, is subject to a 50% penalty on the amount not distributed. You should take the distribution as soon as you realize it was missed. The penalty is reported on Form 5329 for the year of the missed distribution. IRS can waive the penalty for good cause. To get the penalty waived, you must take the distribution, file Form 5329 without the penalty payment, and include a letter to IRS requesting the waiver of the penalty. It is likely that you will not get a response from IRS. In this case that is good news, as it will mean that they have agreed to waive the penalty. They have three years to come back and say you owe it and they will then be entitled to collect the 50% penalty plus interest and penalties on that amount dating back to when the penalty should have been paid. So be sure you have a good reason for requesting the waiver to avoid being in a worse tax situation.

2.

I just inherited an IRA or Roth IRA from my spouse. What do I do now?

Answer:
Under the tax code you have three options, but your IRA custodian may limit these options. You will need to check with the custodian to see what your options are.

  1. You can leave the IRA where it is and remain a beneficiary. This is generally not recommended. When you start taking distributions they will be accelerated and your beneficiaries may not be able to stretch distributions over their lives when they inherit from you. However, it could be beneficial for a younger spouse who will need funds from the IRA to live on before attaining age 59 ½. Distributions from the inherited IRA will not be subject to the 10% early distribution penalty. Required distributions will begin in the year the account owner, not you, would have attained age 70 ½ or in the year after death if the owner was already 70 ½.
  2.  You can leave the IRA where it is and have it retitled in your own name and social security number. Some IRA custodians may not allow you to do this but it is a simple way for you to get the IRA in your own name. The account is treated as if it had always been yours and distributions to you will begin when you turn 70 ½ or in the year after death of the account owner if you are already 70 ½.
  3. You can move the funds to an IRA in your own name. This can be either a new account or an IRA that you already had in your name. If you are under the age of 59 ½, any funds you take out of an account you own will be subject to the 10% early distribution penalty. The account is treated as if it had always been yours and distributions to you will begin when you turn 70 ½ or in the year after death of the account owner if you are already 70 ½.
Whatever option you use, always be sure to name your own beneficiaries on the account you have inherited. Any required distributions that are missed will be subject to the 50% penalty and are reported on Form 5498 for the year the distribution was missed.


- By Joe Cicchinelli and Jared Trexler

2 comments:

If the living spouse (i.e. the beneficiary) has pretax IRA deposits and was wishing to convert to Roth, they should do so before the change of that inherited account to their name. The warning in (1) is fine, but as with any situation, the devil is in the details. The account value may be small enough that the RMDs are actually preferable to taking it into one's own name.
Also - for a sub-59-1/2 beneficiary, the inherited account offers non-penalty withdrawals, just the tax due. It may be worth keeping as an inherited IRA just to keep this option open.

If the spouse who inherits the IRA wishes to treat it as her own but she wishes to do this at different custodian, does she have to first open an IRA at the current custodian to move the assets into before transferring to the new custodian -or- can she have the inherited IRA assets transferred custodian-to-custodian directly from the IRA titled in the name of the deceased spouse to her own IRA with the different custodian? Or might skipping the step of opening her own IRA with the old custodian create a tax problem for her?

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