A listener wrote to me and asked, “How does the RMD (Required Minimum Distribution) work if I am the beneficiary for my mother that was 81 when she died? She had 2 annuities and a mutual fund.”
The biggest mistake he could make would be to take all of the money out of the IRA. He may put it right back into his own IRA as a rollover, thinking he has dodged the tax man’s bullet. No one can run fast enough to dodge that bullet!! The best way to minimize the tax is to use the “stretch IRA.” He will use the IRS table to determine what percentage he needs to withdraw every year. This will leave the maximum amount still in the IRA to continue to grow tax-deferred. The balance in the Inherited IRA can be invested based on his own goals and risk tolerance. It does not have to remain in the same investments that his mom made. She may have done a good job, so leave the investments alone if they accomplish your goals.
Before he can transfer the IRA to an Inherited IRA, the custodian will require (or at least they should) that the RMD be taken from his mom’s IRA for the year she died (the RMD should be deposited into her new estate account). After his mom’s IRA is transferred to his Inherited IRA, he should begin taking his RMD, based on his life expectancy, by the end of the year after the year his mom died.
If you want your beneficiary to at least have the option of using the “stretch IRA,” you need to be sure you name them specifically as the beneficiary or contingent beneficiary. If no one is named, the estate will be the default beneficiary, and funds will need to be withdrawn within five years. IMPORTANT—The disposition of the IRA is determined by the beneficiary designation(s), NOT your will or even your living trust.
The tax man gets a little trickier when getting the taxes from a non-qualified annuity. An insurance agent recently contacted me to ask about a 1099R that his customer received. Her father passed away last year, and she received one-third of his annuity as beneficiary. She was never told that she would owe income taxes on the difference between what her father paid for the annuity and the value at his death. She had already purchased another annuity with her portion, which means there would be surrender charges when she withdrew the funds to pay the taxes. Fortunately, she does have a 10% penalty-free withdrawal after one year, which should be sufficient to pay the taxes; but unfortunately, the insurance company already paid the agent about a $600 commission on that distribution–OUCH!
On the bright side, at least she didn’t blow the whole $100,000 like one of her brothers did–BIGGER OUCH!!!
