Retirement & Financial Planning Report

When an IRA owner dies and the account passes to the beneficiary, the best choice usually is to leave the IRA in the deceased owner’s name. After Bob Young dies and his daughter Wendy inherits, the account can be re-titled as Bob Young (deceased) IRA, for the benefit of Wendy Wilson, for example. Then Wendy can stretch out required minimum distributions (RMDs) over her life expectancy.

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However, a surviving spouse who has been named IRA beneficiary has a unique opportunity. To see how it might work, suppose Dan Taylor dies and his wife Ellen is the beneficiary. Ellen can roll over Dan’s IRA to an IRA in her own name.

Going forward, Ellen can act as any IRA owner can act. She can name beneficiaries to the account; she can convert all or part of the account to a Roth IRA in her name. Often, such a rollover will enable a surviving spouse to postpone RMDs and thus extend tax deferral.

Note what happens, though, if Ellen is younger than age 59-1/2 and wants to tap this IRA for cash. Not only will Ellen owe income tax, she also may a 10% early withdrawal penalty. In such a situation, Ellen may prefer to keep Dan’s account in his name, and take withdrawals from the inherited IRA, because there’s no early withdrawal penalty on such withdrawals.

Once Ellen reaches age 59-1/2 and the 10% surtax no longer applies, she can roll over the inherited IRA to her own name.

If you inherit an IRA, you can pull out all the money right away. If you don’t need the cash, though, you’re better off leaving the money in the account, where tax deferral can continue. Typically, you’ll be subject to the rules on required minimum distributions (RMDs).

Suppose Mike Hawkins inherits an IRA from his uncle. Mike is 48 years old when he starts RMDs. According to the IRS life expectancy table, a 48-year-old has a 36-year life expectancy. Therefore, Mike can stretch RMDs over 36 years.

Now suppose Mike also has two traditional IRAs. One has $100,000, all from pretax contributions, and the other has $30,000, including $13,000 from nondeductible (aftertax) contributions.

Mike wants to convert $20,000 of his traditional IRAs to a Roth IRA this year. His two traditional IRAs have $130,000, including $13,000 (10%) of aftertax dollars. Thus, his $20,000 Roth IRA conversion will be 90% ($18,000) taxable and 10% ($2,000) a tax-free return of his aftertax dollars.

To make this Roth IRA conversion and calculate the income tax due, Mike can ignore the IRA he has inherited from his uncle. The inherited IRA is drawn down on one schedule; Mike’s own traditional IRAs are taxed under their own set of rules.