Look Out for These Potential Beneficiary Blunders
By Benjamin Maas, CISP, CIP, CHSP
An IRA beneficiary has presented us with a check payable to him. He says the assets are from his father’s Traditional IRA. He wants to establish an inherited IRA at our financial organization. May he do so?
Unfortunately, no. Nonspouse beneficiaries are not allowed to distribute and roll over inherited IRA or qualified retirement plan (QRP) assets. To be able to establish and fund an inherited IRA at your financial organization, he should have made sure that the check was payable to your financial organization for his benefit (e.g., “Financial Organization, Trustee, for the benefit of Cliff Burton’s inherited Traditional IRA”). There is no fix for this situation; the distribution is now subject to income taxes.
We recently executed a rollover into a Traditional IRA at our organization per our client’s written instructions. We later found out the assets were from her father’s 401(k) plan. How should we handle this situation?
A nonspouse beneficiary may not roll over inherited QRP or IRA assets into her own IRA, directly or indirectly. This transaction is an ineligible rollover and, to the extent that the amount exceeds the regular contribution limit, or the individual was otherwise ineligible to make a regular IRA contribution, is an IRA excess contribution. Your financial organization should treat the ineligible rollover amount as a regular IRA contribution on behalf of the IRA owner, reporting it as such on IRS Form 5498, IRA Contribution Information. The ineligible rollover amount, therefore, will be reported in Box 1 of Form 5498, not rollover Box 2.
If the IRA owner directs you to do so, you should remove the amount from the IRA according to the IRA excess contribution correction rules, and report the distribution on IRS Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit Sharing Plans, IRAs, Insurance Contracts, etc. Alternatively, the amount could be left in the IRA, subject to the regular IRA contribution eligibility rules as applied to the IRA owner. The IRA owner also has the option to carry the contribution forward to the next tax year if it is a true excess (subject to a six percent penalty tax).
An IRA owner, age 35, has inherited her husband’s IRA. As the surviving spouse, she has the option to treat his IRA as her own. This option is tempting in its simplicity. Are there any drawbacks?
While the option for a spouse beneficiary to treat the decedent’s IRA as her own (transferring or rolling over the assets to her own IRA) is popular and often makes sense, doing so when under age 59½ has one significant drawback: any future distributions before the surviving spouse reaches age 59½ will be considered early and subject to the 10 percent early distribution penalty tax unless she has a penalty tax exception. If, instead, she chooses life expectancy payments from an inherited IRA, she will be able to take distributions anytime, penalty free. Furthermore, she can delay required life expectancy payments until the deceased would have been age 72 (formerly 70½). Thus, if her husband was of similar age, there are likely to be no required annual distributions before she reaches age 59½. As always, IRA beneficiaries should seek competent tax advice to determine the best payment options for them.
