Sinkorswim

08/03/01 - The Survivor Options For IRAs

By: Frank Armstrong, CFP, AIF

If you have just inherited an IRA, or pension plan that you can rollover into an IRA, you will need to make some critical choices. The "kinder, gentler" IRS gives you some time to decide, but they are still fairly unforgiving of errors. The stakes can be large, so let's look at some of the options. We assume here that the owner had not reached age 70 ½ (The Required Beginning Date) by the time of his/her death.

Your first choice is to retain the IRA under the owner's name with yourself as beneficiary. The implication of that choice is that any distributions required of the owner will now have to be made as if the owner were still alive. So, mandatory distributions must begin when the owner would have turned 70 ½. Regardless of the age of the beneficiary, before the owner's age 70 ½, any distributions made to the beneficiary are not subject to the 10% penalty because distributions made due to death are exempt from the penalty. So, if you, the beneficiary, need distributions before your own age 59 ½, this selection might meet your needs.

Alternatively, if current income is not a concern, and maximum deferral is an objective, you might convert the IRA to your own. Now all distribution requirements are based on your age. But, distributions made before age 59 ½ are subject to the 10% penalty. If you are substantially younger than the owner, this path would let you accumulate longer before being forced to make distributions. However, the chance to take "early" distributions is lost.

There is a third choice: split the IRA into two parts. Determine how much money you will need to fund expected withdrawals before age 59 ½ and keep that amount in the beneficiary IRA. The rest can be shifted to an IRA that you own to support you in later life.

To accomplish any of the above choices, you must make a positive election by the December 31^st of the year following death of the owner. Otherwise, the general rule is that all funds must be distributed to the beneficiary by the end of the fifth year following death. Failure to make the election in a timely manner could be a disaster if the sums involved are significant.

It's important to be aware that a distribution from the Beneficiary IRA may be interpreted as an election to keep the entire IRA as a beneficiary IRA. So, if you want to convert all or part to your own IRA, you should do so before beginning distributions from the Beneficiary IRA.

However you decide to use your inherited IRA, document your choices so there won't be any dispute later with the IRS. A registered letter explaining your decision to the custodian would be a good place to start.

Of course, make sure that your own beneficiary selection is up to date so that your heirs will get the maximum possible benefit that they might be entitled to. And, it's more than likely that investment choices made by the owner will need to be revised to meet the beneficiary's objectives and situation. So, a complete review of investment strategy might be in order.

Note: a subsequent article will deal with the survivor's choices where death of the owner occurred after reaching age 70 ½, the Required Beginning Date (RBD) for mandatory distributions from IRA's and Pension Plans.

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