Welcome to the final in the three part series on “Retirement Accounts Made Easy!”
If you missed Parts One and/or Two, you may read the blogs posted on August 18th with Part 2 posted on August 24th.
I look forward to hearing your thoughts and questions.
*** PART THREE ***
Contributions: Generally, you can’t contribute to an account you inherit. The exception is an account owned by the spouse of the deceased, if that spouse retitles the account in her or his own name.
RMDs: The rules can get complicated, depending on whether you were the spouse of the deceased and whether the deceased was in the process of taking required minimum distributions before he or she died. But generally, beneficiaries of inherited retirement accounts have three options:
- Transfer the assets to their own IRA: This option is only available to the spouse of the deceased. Once the assets are in the spouse’s account, RMDs and early withdrawal penalties (if any) will be determined by the spouse’s age.
- Empty the account within five years: No withdrawals are required in any given year as long as all the assets are distributed within five years of the benefactor’s death. The distributions will be exempt from the 10% early withdrawal penalty normally applied to distributions made before age 59 1/2.
- Stretch the account over the beneficiary’s lifetime: Take RMDs each and every year, starting the year after the benefactor’s death. While this option would require the beneficiary to begin taking money sooner than the five-year option, the rest of the account can be left to grow for decades. But it does mean that any beneficiary, of any age, must take an annual RMD. Even a 1-year-old baby who inherited an IRA from her grandmother would need to take a required distribution each year the account has money in it. This would be the case even if it’s a Roth IRA. Fortunately, these RMDs are also exempt from the 10% early withdrawal penalty.
Note that the third option is available only to named beneficiaries of an account. If the account didn’t have named beneficiaries, or they had already passed away, the account then goes into the overall estate. Anyone who then inherits the account must liquidate it within five years, which could result in a large tax bill and the loss of future tax-advantaged growth; the option to “stretch” the account over a beneficiary’s life has been lost. This is why it’s important to name specific people as the primary and backup beneficiaries of your retirement accounts, and to keep that information updated.
RMD Odds and Ends
Credit denied. If you withdraw more than the minimum in one year, you can’t use that fact to reduce the RMD in the next year (However, it will have that effect to some degree because you’ve reduced the size of the account.)
A Roth conversion doesn’t count, but … Your RMD must exit your retirement account and land in a regular, taxable account. You can’t satisfy an RMD by converting that amount from a traditional account to a Roth account. However, Roth conversions do have the effect of reducing future RMDs, because they reduce the value of traditional tax-deferred accounts (which are subject to RMDs) and increase the amount you have in Roth IRAs (which are not subject to RMDs).
Take your RMD in investments. While you can contribute only cash to a retirement account, there are no rules against distributions being made in shares of stock, shares of funds, individual bonds, or whatever other investments you hold in your account. So if you don’t need the proceeds of your RMD to pay for living expenses, and you like the investments you hold, ask your account provider about doing a so-called “in-kind distribution.” You’ll still owe applicable taxes on the value of the distribution.
Make your requirement altruistic. Each taxpayer can contribute up to $100,000 a year directly from a retirement account to a qualified charity, and the contribution will count toward that person’s RMD. The benefit to you – besides the good karma – is that you won’t owe taxes on the amount of the distribution that goes to the charity. Known as a qualified charitable distribution (QCD), for years this provision was something Congress had to approve annually, and they often did it too late in the year to be useful. But thanks to a law passed in 2015, the QCD is now a permanent part of the tax code.
Ask the IRS for forgiveness. If you didn’t withdraw your RMD on time and are facing that stiff 50% penalty, you can seek a waiver from the IRS by filing Form 5329 and attaching a letter of explanation.
RMD after R.I.P. Yes, Uncle Sam might require a minimum distribution even after the account owner has died. The rules are unbelievably complicated, so if you are settling an estate or have inherited an IRA, do additional research or hire a tax pro.
January 1 is the big day. Your marital status affects your RMDs. As far as the IRS is concerned, if you’re married on January 1, you’re married the whole year, regardless of a death or divorce that occurs on any of the other 364 days.
(Full credit to Robert Brokamp of The Motley Fool 8-1-16)