Kutchins, Robbins & Diamond, Ltd. Certified Public Accountants and Advisors

Individual Retirement Accounts: Inherited IRAs

Taxpayers generally must begin withdrawing money from their IRA or retirement account upon reaching age 70½. The required minimum distribution (RMD) is the minimum amount that must be withdrawn each year.

Taxpayers may withdraw more than the minimum required amount. For a traditional IRA, withdrawals will be included in taxable income except for any part that was already taxed or that can be received tax-free, such as amounts from a Roth IRA.

Calculating the RMD. The RMD for each year equals the IRA account balance as of December 31 of the preceding year, divided by the applicable distribution period, or life expectancy, for the taxpayer’s age in the current tax year.

Year of death. The RMD is calculated using rules for lifetime distributions as if the owner had lived the full year. If the owner died before the required beginning date for distributions, no distribution is required for the year of death.

Inherited Traditional IRAs

A designated beneficiary has several choices when inheriting a traditional IRA.

1) The beneficiary can cash in the IRA, include the amount in gross income, and pay tax on the distribution.

2) If the beneficiary is an individual, the beneficiary can elect to take the entire account balance in the IRA by the end of the fifth year following the year of the participant’s death. No distributions need to be made before the end of the fifth year. This election is available only when the participant dies before the required beginning date for RMD.

3) The beneficiary can leave the IRA in the name of the deceased participant. RMD is determined as follows.

• If the decedent was already receiving RMDs at the time of death, the beneficiary can take distributions over the longer of:

– The beneficiary’s own life expectancy based on IRS tables, using the age of the beneficiary as of his or her birthday in the year following the year of the decedent’s death, reduced by one for each subsequent year, or
– The decedent’s life expectancy based on IRS tables, using the age of the decedent as of his or her birthday in the year of death, reduced by one for each subsequent year.

• If the decedent was not yet receiving RMDs at the time of death, the beneficiary must take out the distributions over his or her own life expectancy. If the beneficiary was the surviving spouse, RMDs do not begin until the decedent would have turned age 70½.

4) If the beneficiary is the surviving spouse of the deceased IRA participant, the beneficiary can treat the IRA as his or her own. This allows the beneficiary to make additional contributions to the IRA (including rollover contributions). It also allows the beneficiary to use RMD rules based on the beneficiary’s life. Early withdrawal penalty rules apply if the surviving spouse is under age 59½.

5) If the beneficiary is the surviving spouse of the deceased IRA participant, the beneficiary can treat the IRA as his or her own by rolling it over to his or her own IRA, or the taxable portion of the IRA can be rolled over to his or her employer-sponsored plan.

Choices 1, 2, and 3 apply to all beneficiaries. Choices 4 and 5 apply only to beneficiaries who are the spouse of the participant.

10% early withdrawal penalty. The 10% penalty for withdrawal before age 59½ does not apply to a distribution to a beneficiary on or after the death of the participant. However, if a spouse chooses to roll the decedent’s IRA into his or her own separate IRA, any subsequent distribution will be subject to the 10% early withdrawal penalty assuming no other exception to the penalty applies.

IRA with basis. Any nondeductible contributions that gave the IRA a basis stay with the IRA after it is inherited by a beneficiary. The basis cannot be combined with
the beneficiary’s basis in his or her own IRAs unless the beneficiary is the decedent’s spouse and chooses to treat the IRA as his or her own.

Inherited Roth IRA

When a Roth IRA owner dies, the minimum distribution rules that apply to traditional IRAs apply to Roth IRAs as though the Roth IRA owner died before his or
her required beginning date.

Distributions to beneficiaries. Generally, the entire interest in the Roth IRA must be distributed by the end of the fifth calendar year after the year of the owner’s
death unless distributions are spread over the life expectancy of the designated beneficiary using the RMD rules. If distributed over the beneficiary’s life expectancy the distributions must begin before the end of the calendar year following the year of death. Distributions from another Roth IRA cannot be substituted for these
distributions unless the other Roth IRA was inherited from the same decedent. If the sole beneficiary is the spouse, he or she can either delay distributions until the decedent would have reached age 70½ or treat the Roth IRA as his or her own.

Combining with other Roth IRAs. A beneficiary can combine an inherited Roth IRA with another Roth IRA maintained by the beneficiary only if the beneficiary either:
• Inherited the other Roth IRA from the same decedent, or
• Was the spouse of the decedent and the sole beneficiary of the Roth IRA and elects to treat it as his or her own IRA.

Distributions that are not qualified distributions. If a distribution to a beneficiary is not a qualified distribution, it is generally includible in the beneficiary’s gross income in the same manner as it would have been included in the owner’s income had it been distributed to the IRA owner when he or she was alive. If the owner of a Roth IRA dies before the end of one of the following, the ordering rules for Roth IRA distributions determines which part may be taxable.

• The 5-year period beginning with the first taxable year for which a contribution was made to a Roth IRA set up for the owner’s benefit, or
• The 5-year period starting with the year of a conversion contribution from a traditional IRA or a rollover from a qualified retirement plan to a Roth IRA,

Designated Beneficiary Not Determined 

If the IRA does not have a designated beneficiary as of the date of death, or the designated beneficiary disclaims his or her interest in the IRA, then the estate can designate one of the estate beneficiaries as the IRA designated beneficiary. The time limit for making this designation is September 30 of the year following the year of the IRA participant’s death. By making this designation, the estate can avoid having the IRA distributed under the 5-year rule.

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