'Am I required to create three new inherited IRAs so that the firm can divide it equally?'
"Once the account clears probate, I'm wondering what our options are." (Photo subject is a model.)
Dear Quentin,
My two siblings and I just inherited a small IRA ($7,000) with no beneficiary designation. Once the account clears probate, I'm wondering what our options are. I'm the executor of the estate and am in the process of obtaining a tax ID to open an estate bank account.
Since the account is so small, can I simply liquidate it, deposit the proceeds into the estate bank account, pay any taxes or penalties next year, and then split the remainder among us? Should we draw straws to see who gets it? Or am I required to create three new inherited IRAs so that the firm can divide it equally?
The Third Sibling
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You can email The Moneyist with any financial and ethical questions at qfottrell@marketwatch.com. The Moneyist regrets he cannot reply to questions individually.
Forget about drawing straws.
Dear Sibling,
This is an awful lot of work for $2,333 each.
Forget about drawing straws. You don't get to decide after the fact that an heir will disclaim their shares so that another sibling gets the entire IRA. If the three siblings are listed as beneficiaries - which can happen through the plan document's default terms or state intestacy law - the 10-year rule may apply. If the estate is the beneficiary, it gets even more complicated.
But there are also several unanswered questions that need to be addressed. What type of IRA is it? If it's a Roth IRA, the distribution rules are different, and qualified distributions may be tax-free. Who does the custodian say is the beneficiary? If there is no designation, the estate may be the default beneficiary. Had the owner reached their required minimum distribution $(RMD)$ date? Was an RMD still owed for the year of death?
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Lump-sum distributions
I'm going to assume, based on what is left in the account, that the owner had already begun taking required minimum distributions. As nonspouses inheriting an IRA, the options for you and your siblings are more restricted. What's more, if the estate is the beneficiary, rather than the siblings, different rules apply.
Here's how the timing plays out: The rules depend in part on whether the owner died before or after the date on which RMDs were set to begin. If the estate is the beneficiary and the owner died before that date, the five-year rule applies: the entire account must be distributed by Dec. 31 of the fifth year after the owner's death. Beneficiaries under age 591/2 are not subject to the 10% penalty for early withdrawal.
If the estate is the beneficiary, rather than the siblings, different rules apply.
In that scenario, the estate could also opt to take a lump-sum distribution instead of waiting out the five years, though doing so all at once could increase the estate's taxable income. If the owner died on or after that date, distributions are required to continue based on the owner's remaining life expectancy. Given my earlier assumption, this is the scenario you're probably facing.
"Unlike a surviving spouse, a nonspouse beneficiary does not have the option to roll over the IRA benefits into his or her own IRA," says law firm Nixon Peabody. "There is no option for a 60-day rollover when a nonspouse beneficiary inherits IRA assets," it adds. "If the assets are distributed directly to the nonspouse beneficiary, the money will be taxed as ordinary income and cannot later be transferred into an inherited IRA."
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Your simplest path ahead
As we're only talking about $7,000, liquidating the IRA may well be the simplest practical solution. It makes sense to ask the IRA custodian whether it can distribute the account to the estate, deposit the proceeds into the estate account, account for any income tax that results, and then distribute the remaining estate assets to the three siblings.
Creating a separate inherited IRA for each sibling may not be necessary if the estate is the beneficiary, and opening up a formal estate IRA may be more trouble than it's worth for such a small account. But don't assume that simply because the account is small you can ignore federal distribution rules. To that point, check out the Internal Revenue Service's Publication 590-B on IRA distributions.
Invest the money wisely. Or just decide to have fun.
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-Quentin Fottrell
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