Inheritance of IRA's

[Guest ilin]

I have a few questions: I'm wondering if there is a difference between Trad and Roth IRA's and how they are inherited.

Does 100% get distributed to the children?

What is a Stretch IRA and how does it work?

Is it different if you have a 401k?

Thanks it for now. Thanks for all the reply!

[Mary Kay Foss]

The default method for distributing an inherited IRA whether it's a traditional or a Roth is to make payments over the beneficiaries life expectancy per the IRS tables.

In some IRA agreements, the inherited benefits must be paid out within 5 years when the owner dies before benefits are required to be distributed. A ROTH IRA is always treated as if the owner died before required distributions commence. This 5 year rule was the default before 2001.

When a child is the beneficiary, they are entitled to all of the benefits - timing of the payout is what differs. Payments over life expectancy is the slowest way that benefits are paid; this gives the maximum stretch. But anyone who is named directly as a beneficiary can withdraw as much as they want in any year so long as they at least take the minimum.

The stretch concept merely means that the beneficiary named is younger than the owner of the account so benefits can be paid over a longer time period. If you don't trust the beneficiary to just take the minimum, you need to use a trust to guarantee the stretch.

A 401k plan typically does not give the opportunities for stretching the payments. If the beneficary of the 401k is not a spouse, good estate planning often dictates that the benefits be rolled to an IRA at retirement.

Inherited benefits from a traditional IRA or 401k are subject to income tax when they are received. The Roth IRA payments are nontaxable (if the account's been in place 5 years or more). All types of inherited retirement benefits can be subject to a 50% penalty if the minimum amount is not withdrawn each year.

[Appleby]

The Roth and Traditional IRA are treated the same for purposes of designating a death beneficiary. The death beneficiary can by anyone or any entity that the IRA owner designates. If the IRA owner does not designate a beneficiary, the IRA plan document may include default beneficiary provisions, which will determine the designated beneficiary.

The stretch IRA is more of a concept than a type of IRA . The concept is allowing the IRA to be continued for the life expectancy of the first generation beneficiary, even after he/she dies. The second-generation beneficiary, and subsequent beneficiaries are allowed to take post-death distributions, using the life expectancy of the first generation beneficiary. Prior to the concept of the stretch IRA, many IRA plan documents provided that a first generation beneficiary could not designate a second-generation beneficiary. Under these documents, the estate of the first generation beneficiary would be the beneficiary, and the assets would be required to be distributed by December 31, of the year following the year the first generation beneficiary dies.

For IRAs, the IRA owner may designate anyone or any entity as the death beneficiary. However, in some states (marital and community property states) the spouse must provide written consent if the IRA owner doe not designate his/her spouse as the sole primary beneficiary of the IRA.

For 401(k) plans and other QRPs, the default beneficiary is usually the spouse, unless the spouse provides written consent to have someone else designated as a primary beneficiary. The plan document should stipulate the applicable rules for beneficiary designations, include default provisions.

If all your questions were not answered, or you need clarification on any area of the above, please post your questions/comments

[Guest godmom]

Welcome back Mary: Can you elaborate on the current rules for Roth IRAs if the owner dies before RMD. It kind of left us hanging.

Comments requested on the following:

Section 1.401(a)(9)-6T A-10 states that an irrevocable qualified annuity started before the owners RMD, and the owner dies before his RMD date, the remaining interest must continue to be distributed over the remaining period over which distributions commenced. The rules in 1.401(a)(9)-3 and 401(a)(9)(B)(ii) or (iii) and (iv) are waived and do not appy.

Questions :a- Does anyone know of a similar rule that applies to IRAs and Roth IRAs?

b- If the answer to a is yes, is this a better method to assert a stretch without the expense of a Trust?

c- If the answer to a is no, is it prudent to purchase a qualified annuity with the IRA funds and thus insuring the stretch without the expense of a trust?

[Mary Kay Foss]

The Roth IRA does not have a Required Beginning Date for the owner of the account so any death is a death before the RBD. For both a Roth IRA and a traditional IRA with a death before the RBD the two payout choices are life expectancy or five year rule with the life expectancy the default. I hope that's more clear than my last post.

The beneficiary of an inherited Roth IRA must commence benefits by 12/31 of the year after the death, but that's as close as you come to an RBD with a Roth.

The regs that you cite regarding annuities encompass the case where the IRA or qualified plan owner has purchased an annuity before the RBD and commenced payments. Any annuity's payout period cannot exceed the life of the owner and the designated beneficiary, it's possible to use an annuity for a stretch but problems may result if the beneficiary dies prematurely for example.

I don't think that trusts are all that expensive; of course I make a living preparing trust returns as well as other income tax returns. If someone used a conduit trust (which the IRS seems to want) and allowed the trustee to accelerate withdrawals for certain needs of the beneficiary the trust reporting should be very simple and could be handled by a layman.

[Guest godmom]

Thanks Mary

Is a conduit trust a qualified trust?

Does the trustee has to file Form 1041, even if the distribution is coming from a Roth IRA?

Is the tax exempt interest from the Roth reported separately, or is it included in the total tax exempt income?

[Mary Kay Foss]

A conduit trust is a qualified trust. Form 1041 is required in any year that the trust has $100 of gross income. If the Roth RMD were paid to the trust (say, in January) and the trustee invested the funds and paid them to the beneficiary quarterly, it's possible that the trust could earn $100 - which it would pay to the beneficiary and a Form 1041 would be required. Ordinarily, though you wouldn't expect that Forms 1041 would be necessary for a conduit trust that is the beneficary of a Roth IRA.

The Roth RMD/tax free income would likely be considered principal of the trust and not required to be reported.

If the IRA were a traditional IRA, each year the RMD would be income to the trust. The trust would deduct any expenses, trustee fees, accounting fees, etc and the net income would be payable to the beneficiary. If you don't want to file Forms 1041 there's still a problem but at least the cost of preparing them would be deductible without worrying about a 2% limitation on an individual Form 1040.