Financial Planning

We are nearing the peak of the baby boom inheritance cycle where one of the most common assets being left is IRAs or other retirement accounts. Due to the advantageous tax deferral nature of such accounts, these investments were usually the last ones utilized to support the older generation. Due to the deferred income obligation associated with these accounts, thorough and well advised planning is critical due to varied potential income tax outcomes based on to whom and how such accounts are transferred. The named beneficiary designation on the account is what controls the disposition of these assets, versus what one’s will or trust documents say. Thus it is critical that beneficiary designations are reviewed regularly to insure they are consistent with one’s wishes and the overall estate and income tax plan of the owner.

Inherited IRA rules vary based on who is the named beneficiary and the age of the account owner at death, however there are three basic options and each has special rules and timing requirements.

1. Assets can be transferred to an “Inherited IRA” where depending on the facts the assets can be drawn down immediately without a penalty; deferred and withdrawn systematically over a specified time period; or possibly required to be withdrawn in total by the end of the fifth year.

2. If you are the spouse of the plan owner you can roll the assets into your own IRA and have them treated as if they are your own IRA assets subject to the same rules and restrictions as other assets in your own IRA or leave the assets in an inherited IRA.3.

3. One can take a lump sum distribution and pay taxes on the full value based on your personal tax rates.

The first thing that must be done is determining the type of plan being inherited

• An IRA (including traditional or employee sponsored) and Roth IRA or;

• A qualified retirement plan such as a profit sharing or 401(K) or a similar plan. Then one determines who the named beneficiary is; spouse, non-spouse; trust, or estate executor;

• If you are the spouse and are the named beneficiary of a traditional, SEP, or Simple IRA your options are:

– Take a lump sum and pay tax in full (no penalty and full access to the after tax proceeds)

– Transfer assets to your own IRA: assets are transferred to your own IRA and you have full discretion to choose beneficiaries. The assets are treated as yours and subject to the same distribution rules as your other assets. If you are young and do not need immediate access to the funds, this could be the most advantageous option as the deferral continues in full until you reach the required beginning date for

your minimum distributions.

– Open an inherited IRA: Assets in the account continue to grow tax free and you are not subject to the early withdrawal penalty (Note: if the account is left to multiple beneficiaries you must establish separate beneficiary accounts by December 31 of the year after death in order for each beneficiary to use their own single life expectancy otherwise the oldest beneficiary’s life will control).

• If the owner was under 70 . at date of death; required distributions are required to start by the later of these two dates;(1) the December 31 following the year in which the owner died or (2) December 31 of the year in which the account owner would have reached age 70

• If the account owner was over 70 ; you must start taking the required minimum distribution over your life expectancy beginning no later than the December 31 following the year of death. (Note: if the original account owner did not take an RMD in the year of death it must be taken by the end of that year)

• If the named beneficiary is a non-spouse individual, you have the following two options:

– Open an inherited IRA where the assets continue to grow. There is no early withdrawal penalties and you can chose your beneficiaries.

• Assets are transferred into an inherited IRA in the name of the original account owner. If the account is left to multiple beneficiaries, you must establish separate beneficiary accounts by December 31 of the year after death so that each beneficiary can use their own single life expectancy. Otherwise the oldest’ s life will control.

• You can access funds whenever you like and are taxed on each distribution however:

• If account holder was under age 70 at death:

– If you intend to take an annual Required Minimum Distribution (RMD), you must begin no later than December 31 following the year of the original account holder’s death.

– You may delay distributions until the end of the fifth year after the year in which the original account holder died, at which time all assets need to be fully distributed.

• If account holder was over age 70:

– Your annual distributions are spread over your expected lifetime.

– If you intend to take an annual Required Minimum Distribution (RMD), you must begin no later than December 31 following the

year of the original account holder’s death.

– If the original account holder did not take an RMD in the year he or she died, you must take the distribution by the end of

that year.

– Take a lump sum distribution and the assets are fully taxed at date of distribution

• If the named beneficiary is a trust:

– Determine if the trust is a qualified trust or a non-qualified trust (consult legal counsel) as the rules are complex and the ultimate method of distribution will vary.

– If it is a qualified trust, the distribution period for the assets can generally be spread over the life expectancy of the named beneficiary.

• Open an inherited IRA in the name of the original account owner for the benefit of the trust (individuals of the trust generally cannot establish their own inherited IRAs unless the IRA was actually distributed out by the trust within the designated post death time period.)

• There are two ways that the trust may take distributions:

• Based on the single life expectancy of the beneficiary, if he or she is

the sole beneficiary of the trust.

• Based on the single life expectancy of the oldest beneficiary if there

are multiple beneficiaries.

• If account holder was under age 70.:

• If you intend to take an annual Required Minimum Distribution (RMD), you must begin no later than December 31 following the year of the original account holder’s death. You may delay distributions until the end of the fifth year after the year in which the original account holder died, at which time all assets need to be fully distributed.

• If account holder was over age 70.:

– If you intend to take an annual Required Minimum Distribution (RMD), you must begin no later than December 31 following the year of the original account holder’s death.

• If the original account holder did not take an RMD in the year he or she died, you must take the distribution by the end of that year.

– If the trust is a nonqualified trust meaning that one cannot use the “look through rules” then it will be subject to the no designated beneficiary rule and required distributions will be calculated under the account owner’s life expectancy or the five

year rule depending on the age when the account owner died.

As can be seen, the rules on inheriting an IRA are very complicated and need to be understood before naming beneficiaries. Furthermore, after death, the executor and all stakeholders must be sure that all deadlines are met regarding determining optimum ownership and if necessary distributing and designating who the ultimate owners will be. There are different rules for other non IRA retirement accounts which need coordination with the plan administrator and estate tax counsel to insure they are properly designated and timely handled as well.