We had a
situation where a father left his IRA to his two children. The father was in
his 70s, the son was in his 50s and the daughter in her 40s. The tax problem was
triggered by having one IRA with two beneficiaries.
There are
certain tax no-no's involving an IRA. One is to have your IRA go to your
estate. An estate has no “actuarial life expectancy,” as only individuals can
have life expectancies. Tax rules require an estate IRA to pay-out much sooner
than may be desired or tax-advantageous. A second no-no is what the above father
had done.
When there
are multiple beneficiaries of an IRA, the IRS requires the IRA to calculate the
minimum required distributions (MRD) based on the life of the oldest
beneficiary. In our case, it wasn’t too bad, as the siblings were within 10
years of each other. Consider an alternate situation: a son/daughter and a
grandchild. In that case the grandchild would be receiving MRDs based on the
son/daughter’s life expectancy, which likely would not be in the grandchild’s
best financial interest.
What to do? Split
the IRA into two: one for the son and another for the daughter. As long as this
is done no later than the last day of the year following the year of death, the
IRS will respect the division. This allows the son to use his life expectancy
for his withdrawals, and the daughter to use her life expectancy.
The jargon
for this is “subaccount,” and if you are in this situation (death in 2011),
please consider dividing the inherited IRA into subaccounts by December 31.
By the way,
there is a tax trap in setting up the subaccounts. These are inherited
accounts, and the IRS requires inherited accounts to retain the name of the
decedent. What do I mean? Say that Adam Jones passed way, so we would be looking
at the “IRA FBO Adam Jones.” When the subaccounts are created, they should be
named (something like) “IRA FBO Adam Jones Deceased FBO Benjamin Jones
Inherited.” If one does not do this correctly, the IRS can (as has before)
consider Benjamin as having withdrawn ALL the inherited IRA and put it into his
own separate IRA. Since he withdrew all the inherited IRA, he has to pay tax on
all of it, not just the minimum required distribution.
I consider
the above tax trap to be unfair, but the IRS has brought down the hammer
before. Do not be one of the unfortunate caught in this trap. We have discussed
before that even an average person may need a tax pro here and there throughout
life. This is one of those moments.
