Inherited IRAs: When You DON’T Want That Check in the Mail

By Beverly DeVeny, IRA Technical Expert

Follow Me on Twitter: @BevIRAEdSlott

I talked to two different advisors this week who had almost the exact same story involving inherited IRAs.

A client inherited a small IRA from a parent and the kind bank employee gave them a check. Wouldn’t this make most beneficiaries happy? The problem is that once funds are distributed from the IRA payable to the beneficiary, they are fully taxable. That’s right, a taxable distribution. No hope of stretching out distributions over a beneficiary’s life expectancy. No hope of doing a 60-day rollover into an inherited IRA with that bank or any other. It is over.

The tax code allows all named beneficiaries the ability to stretch distributions over their own life expectancy at the death of the IRA owner. It also prohibits non-spouse beneficiaries from doing a 60-day rollover of inherited IRA funds. The only way to move the funds from one institution to another is via a direct transfer. The funds go directly from an inherited IRA at Bank A to an inherited IRA at Bank B. The beneficiary does not have the ability to use the funds during the transfer.

That’s what the tax code allows. An IRA custodian can limit the options of a non-spouse beneficiary. They could, in fact, offer no stretch and no direct transfer option thus forcing a taxable payout of the inherited IRA. Perhaps that is what happened in these two cases.

In both instances, the beneficiaries were given no explanations by the banks involved. In one case, there wasn’t even any paperwork filled out; a check just showed up in the mail.

In the second case, the bank was more helpful. Dad had not taken his full required distribution (RMD) for the year yet, so they issued two checks. The first one was for the balance of the RMD and it went to Dad’s bank account. The second check was for the balance of the IRA and was payable to the beneficiary. This bank truly messed things up. Any RMD not taken by the IRA owner must go to the beneficiary. That’s what IRS says; not to the deceased individual or to his estate (unless the estate is the beneficiary). The balance of Dad’s RMD should not have gone into his account.

Bank branch personnel, call center personnel, even financial advisors, CPAs, attorneys and IRS personnel seem to have a very limited knowledge of the rules. Before you rely on anyone’s advice, ask about their level of education in this area. Ask to see the materials from their last training session. If they have to blow off the dust or open the materials for the first time, you may be in serious trouble. If a mistake is made, it is you (the beneficiary) who will have to pay the taxes, interest, and potential penalties. So be careful out there.

For an Ed Slott trained financial advisor, go to our website: www.irahelp.com/find-an-advisor.