Inherited IRA annuities (1 qual, 1 NQ) by college-going grandchild

Submitted by Pamela Kalbfleisch on Tue, 2013-08-06 21:04

Opinions, please!

Confusion has ensued in light of this question: How to best manage the two IRA annuities (one qualified from Great American Financial valued @ $31k, the other one non-qualified from MetLife @ $39k) inherited by my daughter from her paternal grandpa, taking into consideration her need for help paying college tuition now versus the potential future value of distributions over her considerable life expectancy? Also want to minimize her income tax bracket impact as much as possible (currently 10%, she earns about $1,200-1,500 annually). She is 18 now, will be 19 by the end of this year, 12/31/2013. Grandpa passed away last summer on 07/16/2012 at age 83, born 11/6/1927. He was receiving RMD’s from the qualified IRA annuity before he died.

Beneficiary starts college in 2 weeks and must pay about $24k towards total annual cost to attend after scholarships and financial aid are applied to her bursar’s bill. $12k must be paid by 8/13/13, remaining $12k by 12/13/13. Our thought was to take lump sum disbursement of the $39k non-qual IRA from MetLife now, pay the $24k tuition bill which leaves $15k towards next year. About $2k will be taxable of the $39k from this NQ annuity.

FAFSA is already filed for the 2013-14 school year so these inherited annuities are not taken into account for the current school year. We expect to take a huge hit on FAFSA next year with the remaining $15k balance from MetLife NQ annuity going onto her financial aid application, so it is likely she will need more cash for 2014-15 and possibly beyond. If we take payments from the qualified IRA plus lump sum for the NQ IRA, tuition costs will likely drain the entire inheritance by the time she graduates with her bachelor’s degree in May 2017. Master’s and doctorate degrees are in her future, so we are looking at a total of 6-8 years of tuition. Is there a better way to use these dollars to maximize the benefit?

My husband and I plan on cash flowing up to $2,500 per month towards tuition. If we save that for this year and next, it should cover tuition (plus FAFSA) for her last 2 years of undergraduate school when the MetLife NQ annuity inheritance will be drained. We are averse to debt so no loans are even under consideration. Daughter will be on Federal Work/Study program so there is another $1,800/year towards school. Future scholarships will probably be a part of the overall financial picture as well, but I am unable to predict those at this time.

Great American says we have these options for the $31k qualified annuity: 1. Lump sum distribution; 2. Quarterly payments; 3. Monthly payments; 4. Roll over to Beneficiary IRA and take all within 5 years. No mention of stretching the IRA over her lifetime. We are too late in the calendar to request annual payments because beneficiary must begin receiving payments by Dec. 31 of the year after annuitant’s death. If we request annual payments now, that means we wouldn’t receive the first annual payment until Dec. 31, 2014 which is a year too late. (I wish they would have told us that last August when I first contacted them!). Pretty much the entire annuity will be taxable to my daughter, so I am very concerned about her income tax bracket skyrocketing. How should we handle this piece of the puzzle correctly?

MetLife says we have one option only: lump sum distribution of the $39k. Considering our immediate need and the relatively low tax hit, we’re thinking this is the way to go regardless. Unless there’s another option you know of?

Toyed with the idea of having her fund her own Roth IRA for 2013 and 2014 up to her maximum income of around $2k projected for each year. That would keep it out of consideration for the FAFSA, right? Or am I trying to do too much stuff with too little money to go around?

GAH. MY HEAD. IT KEEPS SPINNING. 🙂



Submitted by Alan - IRA critic on Tue, 2013-08-06 21:48

First, please clarify what she inherited. These accounts are either:

  • 1) Qualified annuity – this is an annuity like a 403b purchased by a qualified employer plan
  • 2) Non qualified annuity – this is an annuity purchased by a taxpayer with their own funds
  • 3) IRA annuity – these are annuities in an IRA contract
  • Her accounts cannot be of more than one type – eg if they are both in IRA contracts they are neither qualified or non qualified, they are IRAs. Are both accounts definitely IRAs, or just the Great American?

Submitted by Pamela Kalbfleisch on Wed, 2013-08-07 19:19

Alan, thanks for your inquiries. To clarify, here are the answers:

  • 1) Neither of the two annuities was purchased by any sort of qualified employer plan. Grandpa was a small business owner and, during the time that he was actively working, had no opportunity for retirement investments other than IRA’s, CD’s, and regular investment or savings accounts.
  • 2) The MetLife annuity is fixed rate, non-qualified. Contract was dated 12/27/2001, normal annuity date was 01/01/2013 (which was 5 months after Grandpa’s demise). Grandpa purchased this one with his own funds at the local bank as advised by the bank’s own investment advisor. This annuity is held by the bank in an account (#x-8581) separate from the other annuity. Investment account x-8581 is titled to Grandpa’s name only. Recent statement says “Individual” next to account #. It also indicates “Plan Type: Non-Qualified” on the statement. So in retrospect, perhaps this one is not actually an IRA? It is merely an annuity?
  • 3) The Great American annuity is (I think) an IRA annuity – an annuity in an IRA contract. Contract was dated 11/17/2010, annuity comment date was 11/17/2020. (Grandpa bought this annuity when the contract date came due on an older annuity. He used the funds from the first one to buy the second one. I have no idea if there were any prior such transactions. As an aside, the bank’s investment division sold a 10-year-annuity to an 83-year-old man in ill health which was probably not in his best interest.) Same bank holds this annuity in a separate investment account from the first annuity, account number ending in #x-0390. This investment account is titled “FBO” Grandpa’s name. A recent statement for this investment account says “Premier Select IRA” next to account #. There is no “Plan Type” listed at all. However, I was told by a claims rep at Great American that this contract is “qualified” and all withdrawals would be taxable income.
  • So there really are two separate accounts, one qualified and one non-qualified. My daughter inherits both from Grandpa.

Submitted by Pamela Kalbfleisch on Wed, 2013-08-07 19:44

To further confuse matters, I just found a letter from Great American to Grandpa in July 2011 where GA informs him he is now the owner of his annuity contract:

As previously communicated, (your bank’s investments division) clearing firm recently relinquished custody of the individual retirement custodial account (IRA) under which your Great American Life Insurance Company annuity contract is currently held with (your bank’s investments division). As a result of this change, you will become the owner of your annuity contract and your IRA will be treated as having been converted to an individual retirement annuity (rather than a custodial IRA) subject to the requirements of section 408(b) of Internal Revenue Code. Please note that you received correspondence from (your bank’s investments division) earlier this year indicating that Great American would become custodian of your policy. We wish to clarify that your policy is an individual retirement annuity and accordingly your annuity contract will be individually owned by you and will not have a custodian.You are now listed as the contract owner and your Estate is your primary beneficiary. If you wish to update your beneficiary designation for your contract, please use the enclosed contract/certificate change form.”

I don’t even know what all of this means, except to be relieved that the beneficiary was changed to my daughter on 05/12/2012. 

Submitted by Alan - IRA critic on Wed, 2013-08-07 21:24

All indications point to the following:

  1. The Metlife contract is NOT an IRA, it is a non qualified annuity. The only option now is what Metlife specifies. At least, since grandpa purchased the annuity with already taxed dollars, only the earnings will be taxable when Metlife cashes it out, which is the only option. I cannot help you on the FAFSA impact on all this, just that it will likely cut the aid.
  2. The Great American contract IS an IRA, probably fully pre tax, but grandpa’s tax records should be reviewed to determine if he had been filing Form 8606 indicating a tax basis in his IRA. Any remaining basis would be pro rated among all his beneficiaries for their inherited IRAs, making distributions less than 100% taxable. The term”qualified” is not applicable to an IRA, so you can ignore it. The best option as stated is 4) in your earlier post, except that the 5 year rule does NOT apply to inherited IRAs when the owner passes after their required beginning date. Age 83 is far beyond that date, therefore if the IRA annuity named your daughter as beneficiary, she can transfer it to another custodian (eg Vanguard, Schwab, Fidelity etc) and beginn taking annual RMDs based on her life expectancy. Since she will be 19 at year end, her 2013 RMD will be very small (YE 2012 balance divided by 64 – if 31,000 YE balance then 2013 RMD is only $484.38. I assume both her income is penalized more than her assets under FAFSA, so taking out only the RMD would be less costly. Of course, she is free to take out more than the RMD in any year she chooses to. There is no penalty, just ordinary income tax, possible “kiddie tax” implications for you under which certain income of children becomes subject to the parent’s tax rate. Note that she cannot take a distribution and roll it over, the fund must be moved only by direct trustee transfer, but if she sets up an inherited IRA showing both grampa’s name as decedent and her’s as beneficiary, if Great American makes out the check to her inherited IRA custodian for her benefit (FBO), that qualifies as a direct transfer and will not incur any tax. Again, the proceeds should NOT be in a check made out to her personally or the entire amount will be taxed.

Submitted by Pamela Kalbfleisch on Tue, 2013-10-08 21:04

Great American says my daughter must take her 2013 RMD prior to rolling over the remainder of her grandfather’s annuity/IRA to her new Inherited IRA account at Scottrade in a direct trustee transfer. ’13 RMD amount was calculated using her life expectancy factor of 64.0 for a check amount of $489.32.Great American also says that since the decedent (Grandpa) didn’t withdraw his 2012 RMD then that, too, must be withdrawn before the rollover. I asked if they will make it payable to his estate which is getting close to being settled and closed. They replied, “No, the 2012 RMD is also payable to the beneficiary since she inherited it in 2012”. Is this correct? The ’12 RMD amount was calculated using her Grandpa’s life expectancy factor of 14.8 for a check amount of $2,093.19. I questioned Great American about this. Since the ’12 RMD is assigned to my daughter shouldn’t her factor be used for calculation? This would, of course, result in a lower check, plus less taxes and penalty.So now my 18 y/o daughter – who earned less than $1,200 this summer working part-time – is going to have to pay taxes on RMD’s totaling $2,582.51, plus the penalty for the ’12 RMD that her grandfather failed to take before his July 2012 demise? (I know we can request a penalty waiver from the IRS. Just thinking terms of “worst case scenario” here.)

Submitted by Pamela Kalbfleisch on Tue, 2013-10-08 21:15

Grandpa had 3 other IRA’s besides the one at Great American. He received 2012 RMD’s from those 3 accounts. It’s my understanding that the IRS rules for RMDs are applied across all accounts. One doesn’t have to take RMDs from each separate account, one may withdraw the total RMD amount from any single account or combination of accounts. Is this correct? So I need to figure total values for all 4 accounts as of 12/31/2011, then determine the total RMD amount due for Grandpa in 2012, and subtract from the RMD total whatever RMD check amounts he already received? And THAT final figure is what Great American needs to send my daughter for her/Grandpa’s 2012 RMD from them?

Submitted by Alan - IRA critic on Tue, 2013-10-08 22:24

  • The 2012 RMD is Grandpa’s and is the same as he would have had to take. Your daughter will likely get the penalty waived by filing a 2012 5329 with an explanation of why RMD was late and copy of distribution statement showing the distribution. This RMD can only be paid to the beneficiary, not to the estate. These RMDs will be taxable in the year received, ie 2013.
  • You are correct that RMDs can be aggregated over all owned accounts or inherited accounts from the same decedent. Technically, Great American has no business insisting that these RMDs be taken from their account for this reason. The account should be able to be transferred and the RMDs taken from Scottrade, but as long as they are willing to adjust the RMD for RMDs already taken from other accounts, it is probably not worth arguing with them about not taking any RMD before the transfer.

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