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A Hellacious Inherited IRA Story

Some comments are worth highlighting as they make a great Q&A. A question I received on my article Inheriting or Bequeathing an IRA follows:

Dear Joe,
My Mom passed away in December 2011. Her wishes in her Will were for her assets to be divided equally between myself and my 2 sisters. At some point my Mom listed me as beneficiary of her traditional IRA. The custodian has refused to abide by the instructions in the Will as the beneficiary form supersedes the Will. This is in the state of Tennessee. Is there a way to get the balance of the IRA divided 3 ways without cashing it in for a lump sum payout. We all would like to stretch out the payout. If I choose to disclaim a portion of the balance would it go to my Mom’s estate and enable my other 2 sisters to receive their portion? The tax attorney says to talk to the CPA, and the CPA says to talk to the tax attorney….The amount is around $170,000, so the taxes would be substantial on a payout. Any guidance would be appreciated.

Dear Anne,
If you are the listed beneficiary, and there is no other, by disclaiming the money, it would revert to her estate. The five year rule then applies, all funds must be depleted within 5 years after the owner’s passing. I can’t say whether the custodian will permit a partial disclaiming.
If it were me – I’d take the RMDs each year, pay the tax, and gift the siblings their “share.” You can view Pub 590 to see your RMD, but for example, at 50, the divisor to use is 34.2, so 170,000/34.2 is $4971. You can withdraw more if you wish, but be mindful of where you are in your marginal rate.

Right after I posted the response, The Wall Street Journal published Inherited IRAs: a Sweet Deal / A Generous Benefit for Families Survives a Senate Challenge. This is a great article that discusses the benefit of inheriting an IRA along with some of the pitfalls. But the key thing was that the article introduced me to M.D. Anderson, a tax preparer in Chandler, Ariz who has his own site InheritedIRAHell.com was kind enough to support my advice. M.D.’s response to my request for help follows:

On your reader’s question –

I will generally assume the parent or relative we lost here was older, 70.5 + older is what I will assume in this answer. If THAT is true, there is no 5 year rule but instead, the account can continue to pay out based on the life expectancy of the decedent. Disclaiming with no Contingent beneficiary other than the estate (controlled with or without a Will or Trust) has to be timely done no later than 9 months after the year of death. And, the disclaiming benificiary may not control what happens to the money as well or it would be possibly disqualified under IRS rules.
Of course if the decedent is older than 89 under the newest mortality tables, less than 5 years could apply for year left to pay out while tax deferring and if really old — well the mortality table collapses down to 1 year or less to pay tax on death benefits received.
However, if the person wasn’t yet 70.5 at death, then yes, 5 years is the longest the estate can take to pay out the funds to estate beneficiaries which I assume, are all 3 siblings. Agree, this would equalize minus fees and estate expenses, and help fund the desired result.
But adding in those Executor/trix and statutory percentage of the legal fees, you increase the loss of good money here trying to go that route along with the higher risk a disclaimer action can be questioned by later tax authorities.
So, you got it 100% right in your advice. The gifting idea may be “as good as it gets”, hoping the one designated beneficiary asking these questions isn’t in too high of a tax bracket. The net $ received defeats the stretch potential we have with properly set up inherited/beneficial IRA accounts.
M.D Anderson, InheritedIRAHell.com

Thanks, M.D. ! There are a few things to learn from all of this. If the mom truly meant to have her three children as beneficiaries of all of her assets, her retirement accounts should have reflected this before her passing. The sibling trying “to make it right” has her work cut out for her given the rules surrounding IRAs and their inheritance. The concept of the IRA and Roth IRA is pretty simple. It’s when the owner passes that things get really messy, and as Anne states above, CPAs and Tax Attorneys even have issues understanding the rules. If you have any questions or concerns regarding your IRA or Roth IRA, why not post a question at my RothMania site and I’ll answer it for you.

  • Roger Wohlner April 17, 2012, 10:43 am

    Thanks for sharing this story. I also saw the WSJ article and agree that it was a good one. My experience over the years is that when clients have used this tool correctly it works very well. Unfortunately stories like the one from your reader are all too common from what I hear from fellow advisors.

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