Inherited IRA - how much RMD my beneficiaries must withdraw first year (i.e. the year I died) and subsequent 9 years?

mjc4maureen · ‎January 22, 2022

I am planning ahead. Say I am age 75 and RMD is happening every year. Then I died suddenly in 2022. My beneficiaries are my daughter and her three minor children who equally inherited my traditional IRA and Roth IRA.

How much do they must withdraw/distribute for RMD first year (i.e. 2022) and the subsequent 9 years? Who determines the amount? How much is enough for the first year? For my grandkids, I believe it is more than 9 years they must withdraw/distribute all of IRA funds but I don't know how long of extension they have. If you can shed the light for all these, that would be so awesome.

Also do they need to create a separate account called "Inherited IRA" under their name from my original IRA account? The taxable RMD they must withdraw will put into some sort of investment account outside of their inherited IRA, correct?

Thank you,

Maureen

fanfare · ‎January 22, 2022

Under the new rules, there is no RMD until the end of the ten year period.

You can take out any amount or nothing.

at the end of ten years, you must take it all out.

If you inherit a huge IRA,

subject to the 10-year liquidation rule for newly inherited IRAs,
to spread the tax impact most evenly over the ten years,
your divisor should be : 10 - N where N is the number of annual distributions you already took.

In other words, with five years to go, you want to take out one fifth of the IRA,

View solution in original post

fanfare · ‎January 22, 2022

" ... if the owner died in 2020, the beneficiary would have to fully distribute the plan by December 31, 2030."

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Opus 17 · ‎January 24, 2022

@mjc4maureen

Since all of your proposed beneficiaries are “non-qualified“ under the new rules contained in the SECURE act, they simply have to follow the 10 year rule. They must withdraw all the money in the account within 10 years; there are no other withdrawal requirements even if you have already started your RMD yourself.

An “eligible” beneficiary is your spouse, your minor child, a disabled individual, or any other person who is less than 10 years younger than you. All of your proposed beneficiaries, including your adult children and your minor grandchildren, will be nonqualified beneficiaries. That means they follow the 10 year rule regardless of whether or not you have started your RMD‘s.

You are correct that if you pass away and you have not already taken a withdrawal for that year that satisfies the RMD rule, your heir or executor must take an RMD for you before the remainder of the account balance is distributed to the beneficiaries. ~~Since the withdrawal would occur after the date of your death, the income would be taxable on an estate tax return rather than your final personal tax return~~.

[Edited to correct] If your RMD for the year you die is taken after your death, it is distributed directly to the beneficiaries and they pay the income tax.

An inherited IRA must always remain in a designated inherited IRA. Your beneficiaries could do a rollover to a different account custodian (bank or investment company) but it would still be marked as an inherited IRA and subject to the 10 year rule.

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Opus 17 · ‎January 25, 2022

@fanfare

@mjc4maureen

Indeed, I’m just an idiot you’ve never met and I’m not responsible for millions of dollars in IRAs.

Regarding account withdrawals. Once the beneficiary makes a withdrawal and pays the income tax on it, it becomes indistinguishable from any other money in their possession. They could re-contribute it to an IRA in their own name (if they had compensation from working that would allow an IRA contribution, and up to the $6000 per year limit); or they could invest it in a brokerage account where they would be subject all of the usual rules on reporting capital gains, interest, and dividends; or they could buy a Ferrari. Once the tax is paid, it’s all just money.

And of course, if they take 10% out for the first three years, they will probably have more than 70% of the original balance left over, because of growth of the remaining balance in the meantime (unless the stock market is in the tank again).

Certainly, if you established a trust account for each of your minor grandchildren and designated the trust account as the IRA beneficiary, you could ensure that they only had supervised and limited access to the money when they turned 18 and full unsupervised access at a later age when they might be slightly more financially responsible.

Regarding your estate. Generally speaking, any money that you earn after the date of your death is paid to your estate, not you. Your final tax return form 1040 can be filed by your executor, but only covers income paid to you up to the date of your death. Income paid to your estate would be reported on a form 1041 estate tax return. How much tax your estate pays is something that I am not qualified to begin to discuss, although generally yes, you would not be subject to an additional estate tax unless your estate plus your lifetime gifts on form 709 exceeded the exclusion, which is currently between $11 and $12 million.

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Opus 17 · ‎January 29, 2022

@macuser_22

I believe the five-year rule does apply to beneficiaries, see the example in publication 590-B. However, the clock does not reset. If the five-year rule was already met with the regard to the account in general and to any conversions, then it does not restart, but if the five-year clock is not met with respect to a conversion, that clock still counts for the beneficiary.

Also, if you scroll up, you will see that the taxpayer is concerned with the possibility that their executor would have to withdraw an RMD after their death if they did not take it while they were alive. That RMD would be reported on an estate tax return since it was taken after death, as I understand such things.

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Opus 17 · ‎January 29, 2022

@mjc4maureen wrote:

Got it. Thanks. You possess the knowledge I don't have. I really appreciate your sharing. Three more questions if I may ask.

(1) Roth Inherited IRA - is tax free as long as fund is there longer than 5 years as I understand. So if my beneficiary withdraws all of it once on the 10th year, then it should pass 5 years mark therefore, all is tax free. In other words, no income tax needs to be reported, right?

OK, let me take one more stab at this.

The short answer is the 5 year clock only runs once. It doesn't restart when you die, but it must run at least once. If you die and the account is open less than 5 years, your beneficiaries will pay income tax (but not the 10% penalty) if they withdraw earnings before the 5 years is satisfied. They can withdraw regular contributions and conversion contributions without tax or penalty.

If you met the five year rule before you died, then all withdrawals by your beneficiaries are tax-free. The clock does not start over.

Here is the technical explanation.

Roth withdrawals can be qualified or unqualified, and they can be early or not. These are two different things. A withdrawal is not qualified if it is within the 5 year clock (even if the owner is over age 59-1/2), and there is a separate clock on each conversion. A withdrawal is early if the owner is under age 59-1/2, except that beneficiaries are exempt from the 10% penalty.

A withdrawal of contributions is never taxed.
A withdrawal of a conversion that is not qualified (less than 5 years since the conversion) is subject to the 10% early penalty but not regular income tax.
A withdrawal of earnings that is not qualified (account open less than 5 years) is subject to the 10% penalty and regular income tax.

Again, remember the account has a 5 year clock and each conversion has a separate 5 year clock. And also remember that a beneficiary does not pay the 10% penalty but they can still be subject to the regular income tax on non-qualified withdrawals.

So if the account was open less than 5 years, the beneficiary will pay regular income tax if they withdraw earnings before the original owner's 5 year clock is satisfied. They don't pay tax on the contributions or on conversion contributions (because even if a conversion contribution is less than 5 years for its own clock, you don't pay income tax on non-qualified withdrawals of conversions, only the penalty, and beneficiaries are exempt from the penalty.)

View solution in original post

Opus 17 · ‎January 29, 2022

"What about my other questions from my previous email?"

This forum format does not lend itself to consolidated answers, unfortunately. I have a regular life (more or less) and was not online as you posted your questions.

@mjc4maureen wrote:

Great answers. I never know there are many 5 years clocks running. Now I know. Thanks.

And please correct me if I don't understand you right. My Roth account was opened since 2005. As I retired in 2015, after that, every year I did Roth conversion. Say, I died in 2022 and the last Roth conversion I did was in 2022. My beneficiaries must pay income tax for withdrawing the earning of the Roth Conversion portion which occurs between 2018 and 2022 and pay no 10% penalty.

No, you misunderstood. Each conversion has a 5 year clock, and you have a personal lifetime 5 year clock. Based on this new (to me) information, you have already fulfilled your personal 5 year clock (in 2010).

Yes, Fidelity does keep track of the conversions, but the earnings from each conversion are not kept separate. You have three types of funds in your account, contributions, conversions, and earnings. All earnings are counted together.

Because each conversion has its own 5 year clock, an account holder will pay the 10% penalty for early withdrawal if they withdraw that particular conversion money before its own 5 year clock is up, unless the person is exempt from the 10% penalty. (Income tax is never owed when a conversion is withdrawn because the tax was paid at the time of the conversion.) You are exempt from the 10% early withdrawal penalty if you are over age 59-1/2, and your beneficiaries are exempt from the 10% penalty because all beneficiaries are exempt from the penalty.

===>>>Bottom line is, because you opened your Roth in 2005, all withdrawals by your beneficiaries will be tax free no matter when you pass away or how long it was since the last conversion. (It would have helped to know the 2005 date sooner.)

(The separate 5 year clock for each conversion only penalizes people younger than age 59-1/2 who misuse the Roth IRA by converting money and then withdrawing it. Without that rule, you could dodge the 10% penalty on early withdrawal of a traditional IRA by converting to a Roth and then withdrawing from the Roth. There is no 10% penalty for beneficiaries.)

View solution in original post

Opus 17 · ‎January 29, 2022

@mjc4maureen

With luck, I can wrap this up, referencing your original question and the additional information you have added, and leaving out the mistake I made.

For your traditional IRAs, the accounts will be transferred to your beneficiaries as "inherited IRAs". They can rollover the money to a different broker if they like, but it must remain an inherited IRA (this designation will be applied by the broker). They must withdraw the funds within 10 years, and pay regular income tax when they do so. They have no other withdrawal requirement or schedule to follow, even if you have passed your RMD starting date before you died.

If you did not take your RMD for that year from a traditional IRA before you died, the RMD must be calculated and distributed to your beneficiaries, who pay the income tax, before the remaining balance can be divided. This is one of the duties of your executor, and your broker will certainly help. The RMD does not go on your final tax return or on an estate tax return.

For your Roth IRAs, since you opened your Roth IRA in 2005, you have already fulfilled your 5 year holding period. Your beneficiaries will receive Roth IRA account also labeled as "inherited." Your beneficiaries must withdraw all the funds within 10 years, there is no other required schedule. All withdrawals by your heirs will be tax-free, regardless of the date of your death or any IRA to Roth conversions you have done recently. Roth IRAs have no RMD requirement, so there is no "final RMD" needed for the year of your death.

Once the beneficiaries withdraw the money (and pay tax, if it is withdrawn from a traditional IRA) they can do anything with the money that they want, it's all just money at that point. They can contribute to a new IRA (if they have compensation from working) or they can invest in a broker account, or pay college tuition, or anything else that can be done with money. The one thing they can't do is rollover or convert the inherited IRA into a regular IRA in their own name and keep the money for the rest of their lives. They must withdraw all funds within 10 years.

View solution in original post

fanfare · ‎January 22, 2022

Under the new rules, there is no RMD until the end of the ten year period.

You can take out any amount or nothing.

at the end of ten years, you must take it all out.

If you inherit a huge IRA,

subject to the 10-year liquidation rule for newly inherited IRAs,
to spread the tax impact most evenly over the ten years,
your divisor should be : 10 - N where N is the number of annual distributions you already took.

In other words, with five years to go, you want to take out one fifth of the IRA,

fanfare · ‎January 22, 2022

" ... if the owner died in 2020, the beneficiary would have to fully distribute the plan by December 31, 2030."

fanfare · ‎January 22, 2022

I corrected my post above by replacing it with text directly from IRS Pub 590-B for 2020.

fanfare · ‎January 22, 2022

"Also do they need to create a separate account called "Inherited IRA" "

All the designated beneficiaries need to come forward and verify their identity, at which time the custodian will retitle their share of the IRA as an Inherited IRA with him/her as the beneficiary.

mjc4maureen · ‎January 24, 2022

As to the custodian, if the beneficiary is the minor who will have the inherited account with her parents as her custodian in that inherited account. Does it sound right?

If I haven't taken out RMD for the year I die, my daughter must do so for me. That RMD will be my taxable income when she files my last tax return for me. Does it sound right too?

Thank you in advance for your knowledge and wisdom.

mjc4maureen · ‎January 24, 2022

I just realized the custodian in your reply was referring to the financial institution, say Fidelity or Vanguard. That is good.

However, my earlier questions about minor's inherited IRA account with her parents as her custodian in her account, is a different question to you. Does it still sound right? Thanks.

fanfare · ‎January 24, 2022

If the beneficiary is a minor a parent is also listed on the IRA and can act for the beneficiary.

As I recall, the parent will stay on the IRA until the child reaches 18 and takes action to remove the parent's authority.

Opus 17 · ‎January 24, 2022

@mjc4maureen

Since all of your proposed beneficiaries are “non-qualified“ under the new rules contained in the SECURE act, they simply have to follow the 10 year rule. They must withdraw all the money in the account within 10 years; there are no other withdrawal requirements even if you have already started your RMD yourself.

An “eligible” beneficiary is your spouse, your minor child, a disabled individual, or any other person who is less than 10 years younger than you. All of your proposed beneficiaries, including your adult children and your minor grandchildren, will be nonqualified beneficiaries. That means they follow the 10 year rule regardless of whether or not you have started your RMD‘s.

You are correct that if you pass away and you have not already taken a withdrawal for that year that satisfies the RMD rule, your heir or executor must take an RMD for you before the remainder of the account balance is distributed to the beneficiaries. ~~Since the withdrawal would occur after the date of your death, the income would be taxable on an estate tax return rather than your final personal tax return~~.

[Edited to correct] If your RMD for the year you die is taken after your death, it is distributed directly to the beneficiaries and they pay the income tax.

An inherited IRA must always remain in a designated inherited IRA. Your beneficiaries could do a rollover to a different account custodian (bank or investment company) but it would still be marked as an inherited IRA and subject to the 10 year rule.

mjc4maureen · ‎January 25, 2022

Thanks for your response. I learned a great deal from you.

I got hung with the Inherited IRA account balance piece. Say, my grandkid receives $1 million traditional IRA from me because of my passing. Every year she will plan to take out $100,000 from her inherited IRA. So after year 3, her Inherited IRA balance would be $700,000. The accumulated $300,000 should have been taken out will be in her saving account or investment account or some sort, right? In other words, while her inherited IRA is shrieking, her personal investment account is growing. Her investment account doesn't have be marked as the inherited IRA, right? Sorry for the minute detail. Just want to be crystal clear. Pardon me.

Also you mentioned my last RMD will be taxable for my estate tax return. If my estate is less than Federal limit (i.e. $11M ish), I would not need to pay estate tax but a regular income tax on the last RMD piece and other income I received during the year I die. Is that right? You just hop me over to the estate tax return which I know nothing about. Ha.. I am excited to learn something new every day.

And thank you very much for sharing your knowledge. I truly appreciated it.

fanfare · ‎January 25, 2022

If you are talking millions, you need an estate planner for a trust for minor grandchildren.

Do you really want to put one million dollars into the hands of an 18 year old?

They would have no idea what to do other than to spend it.

Opus 17 · ‎January 25, 2022

@fanfare

@mjc4maureen

Indeed, I’m just an idiot you’ve never met and I’m not responsible for millions of dollars in IRAs.

Regarding account withdrawals. Once the beneficiary makes a withdrawal and pays the income tax on it, it becomes indistinguishable from any other money in their possession. They could re-contribute it to an IRA in their own name (if they had compensation from working that would allow an IRA contribution, and up to the $6000 per year limit); or they could invest it in a brokerage account where they would be subject all of the usual rules on reporting capital gains, interest, and dividends; or they could buy a Ferrari. Once the tax is paid, it’s all just money.

And of course, if they take 10% out for the first three years, they will probably have more than 70% of the original balance left over, because of growth of the remaining balance in the meantime (unless the stock market is in the tank again).

Certainly, if you established a trust account for each of your minor grandchildren and designated the trust account as the IRA beneficiary, you could ensure that they only had supervised and limited access to the money when they turned 18 and full unsupervised access at a later age when they might be slightly more financially responsible.

Regarding your estate. Generally speaking, any money that you earn after the date of your death is paid to your estate, not you. Your final tax return form 1040 can be filed by your executor, but only covers income paid to you up to the date of your death. Income paid to your estate would be reported on a form 1041 estate tax return. How much tax your estate pays is something that I am not qualified to begin to discuss, although generally yes, you would not be subject to an additional estate tax unless your estate plus your lifetime gifts on form 709 exceeded the exclusion, which is currently between $11 and $12 million.

fanfare · ‎January 26, 2022

[removed by me]

mjc4maureen · ‎January 28, 2022

Got it. Thanks. You possess the knowledge I don't have. I really appreciate your sharing. Three more questions if I may ask.

(1) Roth Inherited IRA - is tax free as long as fund is there longer than 5 years as I understand. So if my beneficiary withdraws all of it once on the 10th year, then it should pass 5 years mark therefore, all is tax free. In other words, no income tax needs to be reported, right?

(2) It sounds like my executor needs to file the year I die both the 1040 and the 1041 tax returns. Yes? And 1041 tax return only needs to be filed one time not every year thing because we only die once, right? In fact, these would be my last tax returns. No more after that.

(3) Does Turbo Tax Premier version enable us to file both Estate tax return (1041) and Income tax return (1040)?

P.S. Since I have been laughed by you guys about grandkids inheritance, I am thinking over a bit. Thanks guys.

fanfare · ‎January 29, 2022

No one is ls laughing. It is not a laughing matter.

If your estate is not closed, your executor may file an estate tax every year.

Think Elvis Presley.

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Inherited IRA - how much RMD my beneficiaries must withdraw first year (i.e. the year I died) and subsequent 9 years?