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
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,
" ... if the owner died in 2020, the beneficiary would have to fully distribute the plan by December 31, 2030."
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.
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.
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.
@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.
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.)
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,
" ... if the owner died in 2020, the beneficiary would have to fully distribute the plan by December 31, 2030."
I corrected my post above by replacing it with text directly from IRS Pub 590-B for 2020.
"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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
@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?
(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.
[Edited, see below for correct answer.]
1. The 5 year rule applies once per individual (must be opened at least 5 years in your lifetime) and once per conversion. This clock does not reset for the beneficiaries. Suppose you opened IRA in 2020, did an IRA to Roth conversion in 2022, another conversion in 2028, and died in 2030. The contributions, conversions and earnings get allocated proportionally to the beneficiaries. Because you met the 5 year rule for the account in general, and you met the 5 year rule for the 2022 conversion, that part of the account is qualified for the beneficiaries. The 5 year rule for the 2028 conversion would be satisfied in 2033. And remember that the owner must withdraw contributions first, conversions second, and earnings last. That would mean that your beneficiaries could withdraw the balance attributed to the contributions and first conversion at any time without tax or penalty. If they withdraw the balance attributed to the 2028 conversion before 2033, they pay income tax. Then when they withdraw earnings, they are not taxed. The account would have to be closed out by 2040.
2. Your estate files an estate tax return if it ever has income. Most of the time, that just means once, if you have income after the date of your death. But many people have estates that last a long time and continue to earn money and file tax returns (Elvis Presley, Michael Jackson, many authors, etc.)
3. The form 1041 estate tax return can only be filed using Turbotax Business. The program is different from "home and business" and is only available as a CD or download for PC, there is no Mac or online version.
4. We aren't laughing about your grandkids, but we are pointing out that young adults are often irresponsible with money, and there are ways of putting a fence around the money (or part of the money) until they are more mature.
@mjc4maureen wrote:
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.
If you have named beneficiaries in the IRA and your estate is not the beneficiary then it passes directly to the named beneficiaries by the IRA custodian and the executor has nothing to do with it and never sees it.
The 5 year rule does not apply to beneficiaries.
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.
@Opus 17 wrote:
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.
Per IRS PUB 590-b
[quote]
The 5-year period used for determining whether the 10% early distribution tax applies to a distribution from a conversion or rollover contribution is separately determined for each conversion and rollover, and isn't necessarily the same as the 5-year period used for determining whether a distribution is a qualified distribution.
Unless one of the exceptions listed later applies, you must pay the additional tax on the portion of the distribution attributable to the part of the conversion or rollover contribution that you had to include in income because of the conversion or rollover.
You may not have to pay the 10% additional tax in the following situations.
You have reached age 59½.
You are totally and permanently disabled.
You are the beneficiary of a deceased IRA owner.
You use the distribution to buy, build, or rebuild a first home.
The distributions are part of a series of substantially equal payments.
You have unreimbursed medical expenses that are more than 7.5% of your adjusted gross income (defined earlier) for the year.
You are paying medical insurance premiums during a period of unemployment.
The distributions aren't more than your qualified higher education expenses.
The distribution is due to an IRS levy of the qualified plan.
The distribution is a qualified reservist distribution.
[end quote]
Even with that exception, it says you may not have to pay the additional tax.
I agree with Opus 17 ; the Pub 590-B is ambiguous/contradictory on this topic.
You didn’t read far enough. Keep going to “Distributions to beneficiaries”.
[Edited to add: The section below applies to inherited Roth IRA accounts, and not traditional IRA accounts.]
Distributions that aren't qualified distributions.
If a distribution to a beneficiary isn't a qualified distribution, it is generally includible in the beneficiary's gross income in the same manner as it would have been included in the owner's income had it been distributed to the IRA owner when he or she was alive.
If the owner of a Roth IRA dies before the end of:
The 5-year period beginning with the first tax year for which a contribution was made to a Roth IRA set up for the owner's benefit, or
The 5-year period starting with the year of a conversion contribution from a traditional IRA or a rollover from a qualified retirement plan to a Roth IRA,
each type of contribution is divided among multiple beneficiaries according to the pro-rata share of each. See Ordering Rules for Distributions, earlier in this chapter under Are Distributions Taxable.
Example.
When Ms. Hibbard died in 2020, her Roth IRA contained regular contributions of $4,000, a conversion contribution of $10,000 that was made in 2016, and earnings of $2,000. No distributions had been made from her IRA. She had no basis in the conversion contribution in 2016.
When she established this Roth IRA (her first) in 2016, she named each of her four children as equal beneficiaries. Each child will receive one-fourth of each type of contribution and one-fourth of the earnings. An immediate distribution of $4,000 to each child will be treated as $1,000 from regular contributions, $2,500 from conversion contributions, and $500 from earnings.
In this case, because the distributions are made before the end of the applicable 5-year period for a qualified distribution, each beneficiary includes $500 in income for 2020. The 10% additional tax on early distributions doesn't apply because the distribution was made to the beneficiaries as a result of the death of the IRA owner.
I never said the beneficiary paid the 10% penalty. The beneficiary might have to pay regular income tax if the five-year holding period has not been that for a conversion or for the entire account.
Although I now realize that my example was partially incorrect because I also misunderstood the rule, but in a different way than you thought I did. I will make a correction.
@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.
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.)
Like I said on another thread:
How am I supposed to know when my Inherited Roth IRA was initiated?
Is the custodian required to inform me?
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.
And I am curious to know if my Roth IRA is clearly marked by say Fidelity "regular" vs "conversion" contribution and what year I did regular contribution or conversion and how much contribution for each. Really? If so, I am impressed by it.
And it is very good to know that beneficiaries can withdraw regular contribution and conversion contribution with no penalty and no income tax.
However, per my instruction to my beneficiaries, if they follow (ha), they won't withdraw any Roth inherited IRA till the year of 2032 for this case, then everything is tax free (i.e. no penalty no income tax). All the earnings will way pass 5 years mark as I see it. Did I miss something? I know I am not a smart bulb. Hehe..
What about my other questions from my previous email?
And I wish you a good weekend.
Thanks,
Maureen