Personal Finance

Money Matters: Sibling seeks advice after inheriting brother’s IRA

Q. I read your column about the granddaughter inheriting from her “Mimi’s” IRA and freaked out. My brother died in 2014 and I was named his sole beneficiary of his rather large IRA (over $400,000). I think I set it up properly as a beneficiary IRA, his name as deceased owner for benefit of “my name.” I was under the impression that I didn’t need to begin any distributions until I reach age 70 1/2. If I read your column correctly, I should have taken a distribution last year and need to do so each year. Is this correct and if so what do I do now?

A. With one exception, when you inherit an IRA from anyone other than spouse, you must take a required minimum distribution (RMD) from the IRA each year beginning the year after the original IRA owner’s death. The RMD amount is calculated using the IRS beneficiary life expectancy table and your age. If you don’t take your RMD you will be charged a 50 percent IRA penalty and still owe income tax on the amount you should have taken. You can always take more than the RMD but not less without penalty. You can ask the custodian to withhold federal and state income tax or not, unless your state requires withholding.

An exception to this is the five-year rule. If the original account owner (your brother) died prior to age 70 1/2 you may elect to use the five-year rule. If you use this rule, you do not have to begin RMDs the year following the original IRA owners death. You can withdraw assets from your inherited IRA at anytime and in any amount. The catch is that under this rule all assets must be withdrawn by December 31st of the fifth anniversary year following the original owners death. Since your brother died in 2014, the account would need to be depleted by December 31, 2019. This may be one way to avoid the 50 percent penalty on any missed RMDs. However, since all withdrawals are included in your taxable income this approach could have a significant impact on your taxes. With such a large IRA, you’d probably be better off paying the penalty on the one missed RMD in 2015.

You could also try to get a waiver from the IRS on your missed RMD. To have the 50 percent penalty waived you must show the IRS that you have corrected your error, so go ahead and take the RMD amount that should have been taken last year. You will then file the 2015 IRS Form 5329, Additional Taxes on Qualified Plans (including IRAs) and Other Tax-Favored Accounts. Filing this form doesn’t require that you prepay the penalty but if the penalty is not waived, you may owe interest on the penalty payment. With Form 5329, include a letter stating why the 2015 RMD was not taken, that it has now been taken and that a plan is in place to insure that future RMDs will be taken. You may hear back from the IRS within a few months but know that if you don’t hear back from them in three years, the waiver is deemed granted. A consultation with a knowledgeable tax person or financial adviser may be of benefit.