Personal Finance

Money Matters: Things to know when inheriting an IRA from a non-spouse

Q. I’m still working and I have a 401(k) plan to which I am contributing, a roll-over IRA and an inherited Roth IRA from my brother. I turned 70 1/2 this year, but I don’t think I have to worry about required minimum distributions from my 401(k) and IRA until next year when I plan to retire and will no longer be contributing to my 401(k). Is that correct? The Roth I plan to leave intact since it is not subject to tax and have named my children as beneficiaries. Will they get to take tax-free distributions based on their own life expectancies or is it based on the oldest child’s life?

A. We may have some problems here. If you inherited the Roth IRA in 2014 or 2015 you are fine so far. If you inherited the Roth IRA prior to 2014, you may be facing a penalty of 50 percent of what you should have taken as a distribution for each year after the year in which your brother died. When a person inherits an IRA, either a traditional or a Roth, from anyone other than a spouse, a required minimum distribution (RMD) needs to be made by Dec. 31 of the year following the deceased IRA owner’s death and every year thereafter. The only difference is that the RMD from the traditional IRA will be subject to tax and the RMD from the Roth IRA will be tax free. Anytime a RMD is missed the IRS will access a penalty of 50 percent of the amount that should have been withdrawn. So, if your brother died in 2014, you need to take a RMD before the end of this year. If your brother died this year you have until Dec. 31, 2016 to take your first RMD. If your brother died prior to 2014 you have missed one or more RMD and eventually the IRS will discover your error.

The IRS may waive the penalty if you can demonstrate among other things that you either received bad financial advice, were involved in a natural disaster, records were lost or were in the hospital. If you missed any RMDs, take steps to correct this as soon as possible. You will use the single life expectancy table in IRS publication 590, the IRA custodian may be able to help you determine the RMD for each of the years you may have missed. Once you’ve made the correct RMDs file IRS form 5329 and attach an explanation that you have taken the steps to correct the error and any reason you have for not making the RMDs. The assistance of a tax or financial professional may be wise. Beneficiaries of an inherited IRA will need to use the life expectancy of the deceased inherited IRA owner to determine their RMD. These beneficiaries are called successor beneficiaries.

You are correct that you needn’t take an RMD from the 401(k) plan while you are still working at the company offering the plan. The roll-over IRA is subject to RMDs even though you are still working. Since you turned 70 1/2 this year you have the option of taking your RMD from the IRA either this year or anytime before April 1 of 2016 (the year after you turned 70 1/2). If you delay your 2015 RMD until 2016 you will still have to take your 2016 RMD from this IRA so, you will need to take two taxable RMDs based on the value of this IRA in 2016. If you retire in 2016, you will need to take a taxable RMD from your 401(k) as well. From a tax standpoint, depending on your 2015 income, it may make sense to delay taking your RMD from your roll-over IRA to 2016. Again, a meeting with a tax or financial professional may be a good idea.