Many of you may have seen articles where I've mentioned the various taxes and penalties associated with the multitude of retirement plans out there.
Generally speaking, when one has a traditional IRA or Rollover IRA from a work sponsored retirement plan or old 401K that was left behind when one retires, the rules are pretty straightforward.
You are required to begin Required Minimum Distributions (RMD) by April 1st of the year after one turns 70 ½. Doesn't really sound all that straightforward to me.
The good news is, our clients don't have to worry about this if they are working with us as we handle these calculations and make sure these distributions are correct.
Occasionally we would come across someone that wasn't taking money out as required or the incorrect amount was being distributed. We would then help fix these issues and make sure going forward things were done right.
But lately, I have received calls or sat down with new clients where we discovered some pretty serious issues with inherited IRA's.
Namely, they weren't taking money out of inherited IRA's correctly or worse, not at all!
So, how is this supposed to work? Well, first we have to determine if the one that inherited the IRA, was married to the person that passed away. Why is this important? Well, if one is married to the person when they pass away, they may not have to take a distribution at all. This rule is predicated on whether the deceased was taking required minimum distributions (RMD) and the age of their surviving spouse.
But what if I inherit my uncle's IRA. Do I have to take a distribution?
Doesn't matter if your uncle was taking distributions or not at the time of his death. You would be required to take these required minimum distributions. (Something called the "Five Year Rule" can apply instead, but money still has to come out and taxes need to be paid. Give me a call to learn why the 5 year option may not be in your best interest). Bear in mind, one can take 100% of the account balance at any time. However, taxes are due on any amount of distributions from a traditional IRA, 401k, 403b, SIMPLE plan, SEP IRA etc.
So, the bottom line is, whether a distribution is required or not, you most likely have to pay taxes on money coming out of these retirement accounts. (Well I say most likely unless if it is a very low balance or you have no other income, you may not have a tax liability.)
There is an exception to the tax rule. If you inherit a Roth IRA, there are no income tax ramifications (assuming the account is at least 5 years old). RMD's still apply if a non-spouse inherits these accounts but there are no taxes to pay.
So what happens if I don't take these RMD's out on a timely basis? (Inherited IRA's these distributions must be done each year by 12/31. The first distribution must occur by 12/31 of the year after they pass away.)
Ex. Carl's uncle Tim dies on April 14th 2019. Carl's first RMD must come out of the account by 12/31/20.
There are also rules on how these accounts must be titled.
Okay, so what's the deal with the 50% tax penalty?
If you do not take these Required Minimum Distributions on a timely basis, you are subject to a 50% on the amount that was supposed to come out but didn't.
Ex. Carl's uncle Tim's IRA required a distribution of $26,000 this year. If Carl did not take this RMD, he would be subject to the 50% tax or an additional $13,000 tax on top of the regular tax based on Carl's tax bracket.
By the way, the 50% tax penalty also applies to inherited Roth IRA's by a non-spouse as well.
Sounds confusing? It can be.
In all cases of retirement plan withdrawals or transfers (whether inherited or not) please reach out to us. Doing the wrong thing can be irrevocable and you usually only have one chance to get this right.
We are here to help.
All the best.
Rick Fingerman, CFP®
Financial Planning Solutions, LLC (FPS) is a Registered Investment Advisor. Financial Planning Solutions, LLC (FPS) provides this blog for informational and educational purposes only. Nothing in this blog should be considered investment, tax, or legal advice. FPS only renders personalized advice to each client. Information herein includes opinions and source information that is believed to be reliable. However, such information may not be independently verified by FPS. Please see important disclosures link at the bottom of this page.