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

[Opus 17]

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@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.

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[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. 

[macuser_22]

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@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.

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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.

[Opus 17 · Accepted solution]

@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.  

[macuser_22]

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@Opus 17 wrote:

@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.

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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]

[fanfare]

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.

[Opus 17]

@macuser_22 

@fanfare 

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.

[Opus 17]

@fanfare 

@macuser_22 

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.  

[Opus 17 · Accepted solution]

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@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? 

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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.)

[fanfare]

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?

[mjc4maureen]

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

[mjc4maureen]

Hi Opus 17,

You did answer my other questions (e.g. Turbo Tax Business version I need).   Sorry for not reading your emails sequentially unintentionally though.

(1) And I am no Elvis Presley or Michael Jackson.  So, once custodian retitles my share of investment, retirement and bank accounts to my beneficiaries, I have no money left.    So I would have estate tax return filed only once and I am done I think.

(2) When you said "your estate files an estate tax return", who is that person?  My Will executor?  In this case it will be my daughter who is my beneficiary too.  

(3) If my last RMD withdraw after my death will be reported on estate tax return, that RMD is added to the estate.  As long as my estate doesn't reach estate tax exclusion, that RMD doesn't incur tax consequence.  A bit loophole here, isn't it?  In other words, no tax paid on that last RMD for this case.

Look forward to hearing your wisdom soon.   Thanks.

[mjc4maureen]

Hi Opus 17,

Or you meant my beneficiaries must pay income tax for withdrawing the earning of the Roth Conversion portion which occurs between 2018 and 2022 no matter when they withdraw.  It could be 2032 they withdraw all at once, they still need to pay income tax for the earning of that Roth Conversion portion between 2018 and 2022.  I don't know the answer.  Shed the light again?

Thanks,

Maureen

[macuser_22]

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@mjc4maureen wrote:

(2) When you said "your estate files an estate tax return", who is that person?  My Will executor?  In this case it will be my daughter who is my beneficiary too.  

(3) If my last RMD withdraw after my death will be reported on estate tax return, that RMD is added to the estate.  As long as my estate doesn't reach estate tax exclusion, that RMD doesn't incur tax consequence.  A bit loophole here, isn't it?  In other words, no tax paid on that last RMD for this case.

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If you have named beneficiaries in your IRA then that passes directly to the beneficiaries outside of the estate and is not included in the estate at all.

The executor  of the estate must pay the tax on your last RMD (from the estate).  That is part of your final tax return filed by the executor and has nothing to do with the estate tax.

[Opus 17]

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@mjc4maureen wrote:

Hi Opus 17,

Or you meant my beneficiaries must pay income tax for withdrawing the earning of the Roth Conversion portion which occurs between 2018 and 2022 no matter when they withdraw.  It could be 2032 they withdraw all at once, they still need to pay income tax for the earning of that Roth Conversion portion between 2018 and 2022.  I don't know the answer.  Shed the light again?

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You have a personal Roth IRA clock that starts in the year you open your first Roth IRA.  If you die more than 5 years after you opened your first Roth IRA, all withdrawals by your beneficiaries are tax-free.  (Even if it is not the same Roth IRA.  Your personal Roth IRA 5 year clock just counts from when you opened your first account.)

Since you opened your first Roth in 2005, you fulfill the 5 year holding period and all withdrawals by your beneficiaries will be income-tax free and penalty-free, no matter when the withdrawal is made.  Withdrawal of contributions is never taxable.  Withdrawal of conversions can sometimes trigger the 10% penalty but beneficiaries are exempt from this, and withdrawal of the earnings is non-taxable since you already fulfilled the 5 year holding period. 

[Opus 17]

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@mjc4maureen wrote:

(2) When you said "your estate files an estate tax return", who is that person?  My Will executor?  In this case it will be my daughter who is my beneficiary too.  

(3) If my last RMD withdraw after my death will be reported on estate tax return, that RMD is added to the estate.  As long as my estate doesn't reach estate tax exclusion, that RMD doesn't incur tax consequence.  A bit loophole here, isn't it?  In other words, no tax paid on that last RMD for this case.

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One of the duties of your executor or personal administrator is to file your final tax return.  If you have any kind of income after your death, that goes to your estate, which is a separate legal entity that comes into existence when you die, because you are no longer a legal entity yourself at that point.  The executor would also be responsible for filing an estate tax return if one was required.  

You are correct that there is not always enough money for an estate to be required to file a separate return.  

I also need to add an important note, and a significant correction.

A Roth IRA does not have any requirement for RMDs.  If you have a Roth IRA, you can leave it alone until you die, and your beneficiaries have 10 years to withdraw it.  There is no final RMD requirement for the year of your death.  The final RMD rule only applies to traditional IRAs.

And the correction; the final RMD for a traditional IRA does not go to your estate, it goes directly to the beneficiaries and they pay the income tax.  See this article, an I apologize for mis-stating the rules.

https://www.kiplinger.com/article/retirement/t045-c000-s004-how-to-handle-taking-a-final-rmd.html