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Can I close and Inherited IRA without huge taxes or penalties?

Manhattan, KS |

I have interest in an Inherited IRA from my mother. The beneficiary of the IRA however was a trust so the owner of this Inherited IRA is a trust company.
I am 1/3 beneficiary of the trust since 2002. This Inherited IRA has been maintained properly making the Required Minimum Distributions to the Trust.
The trust is going to be terminated soon and IRA distributed by the trust in a fasion that will be determined.

What is the best was to handle this Inherited IRA?
Can the Inherited IRA be rolled over into and IRA in my own name?
What is the most tax efficient way to simply get my 1/3 share of the Inherited IRA in a lump sum, closing/terminating it if possible?

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Attorney answers 1


Beneficiaries of IRA's other than spouses have limited options with regard to the IRA's. These other beneficiaries are not allowed to take the deceased person's IRA or retirement plan and roll it over into their own IRA account. Instead, they must contact the financial institution that manages the IRA or retirement plan and set up a new account that specifically refers to the fact that the assets have been inherited.

Once this account is established, tax rules require that taxable distributions from the inherited IRA must begin within a certain amount of time. The beneficiary has two primary options. First, the beneficiary may choose to take out the entire account balance by the end of the fifth year following the death of the original account owner. If the beneficiary chooses this option, then no distributions are required before the end of the fifth year.

Another option applies to beneficiaries who qualify as designated beneficiaries under tax law. In most circumstances, if the original account owner specifically names the beneficiary on the beneficiary designation form, the beneficiary will qualify as a designated beneficiary. Designated beneficiaries can elect to take minimum distributions over the course of their lifetime. The amount of the required distribution is determined by referring to an IRS life expectancy table. By using this method, beneficiaries can greatly extend the period over which they must take distributions, which may result in deferred taxation and a greater ability to incorporate the inherited IRA into their overall tax planning.

Beneficiaries who wish to take distributions over their lifetimes must make sure that they take the first required distribution by the end of the year following the death of the original account owner. While this may seem like a lot of time, keep in mind that in some complicated estates, a beneficiary may not even find out about a retirement plan account until much of the estate administration has been completed. While the five-year rule is always available, it may lead to a less desirable result from a tax perspective.

A recent change in the law made designated beneficiary status a possibility not only for IRA beneficiaries but also for beneficiaries of qualified retirement plan accounts. Prior to the law change, qualified plan beneficiaries often had to resort to the five-year rule.

These guidelines only define the minimum that a beneficiary must withdraw from the account. The beneficiary always has the right to take more than the minimum required. Furthermore, withdrawals from inherited IRAs are not subject to the 10% penalty even if the beneficiary is less than 59 1/2.

Because financial institutions are not always familiar with how to set up inherited IRAs, you should keep an eye on the process to make sure it is done correctly. By knowing the rules yourself, you can ensure that you will be able to make the most of your inheritance.

When the beneficiary of an IRA is a trust, the trust has a life of zero in the eyes of the tax code. Therefore, you cannot then spread the payments over the life of the beneficiary (stretch the IRA) when the beneficiary is a trust. It would have been better to name you as a beneficiary directly. Then a stretch IRA would be possible as described above. This is the best way to handle an inherited IRA.

Any individual seeking legal advice for their own situation should retain their own legal counsel as this response provides information that is general in nature and not specific to any person's unique situation. Circular 230 Disclaimer - Advice given in this response cannot be used to eliminate penalties with the IRS or any other governmental agency.

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