By Bill Bischoff
Melinda Sue Gordon/Universal/Courtesy Everett Collection
In another article, I explained how the IRA required minimum withdrawal rules affect spouses who inherit their husband’s or wife’s IRA. But what if you inherit your Uncle Henry’s IRA, or any IRA that belonged to someone other than your spouse?
Well, the required minimum withdrawal rules in that case are different. And it’s important to understand them, since if you fail to take minimum withdrawals according to IRS guidelines, you can be socked with a penalty equal to 50% of the shortfall. That is one of the harshest penalties in our beloved Internal Revenue Code, your dear departed Uncle Henry didn’t spend all those years saving for that to happen. So do him a favor and pay attention here. Trust me, the payoff will be worth it.
Scenario 1: IRA owner dies before the required beginning date (RBD)
The first thing you need to know is whether the IRA owner (Uncle Henry in this case) died before the required beginning date (RBD) for taking required minimum withdrawals. The RBD is April 1 of the year after the year the IRA owner reaches age 70 ½. If death occurs before the RBD, the tax rules stipulate that a non-spouse IRA beneficiary must begin taking required minimum withdrawals over the beneficiary’s life expectancy. (You can, of course, always take out more than that if you’d like, just keep an eye on how that might affect your tax liability for that year.) The first withdrawal must occur by Dec. 31 of the year following the year the account owner dies. In subsequent years, additional minimum withdrawals must be taken by Dec. 31 of each year. These withdrawals are required in order to avoid the 50% penalty.
So how do you know how much to withdraw for each year? You need to crunch the numbers by dividing the account balance at the end of the previous year by your life expectancy. You can find your life expectancy divisor in Table I of Appendix B in IRS Publication 590-B, which is available on the IRS website at www.irs.gov.
Say your beloved Uncle Henry died in 2018 at age 68 (before his RBD), and you’re the sole designated beneficiary of his traditional IRA. You must take the initial required minimum withdrawal by the end of 2019. Until then, you can leave the account untouched, which from a tax perspective, is a smart thing to do since it allows the account to grow tax-deferred (or tax-free, in the case of a Roth IRA). To figure the minimum withdrawal amount for 2017, you must first determine the appropriate life-expectancy divisor to use. That depends on your age as of the end of 2017. Let’s assume you’re 48 on Dec. 31, 2019. Using Table I in Appendix C of IRS Publication 590, you find the single life expectancy for a 48-year-old person is 36.0 years. Now divide the Dec. 31, 2018, account balance, say $250,000, by 36.0 to come up with your 2019 minimum withdrawal amount of $6,944. You must take out that amount (at least) by Dec. 31, 2019, to avoid the 50% penalty.
Your 2020 required minimum withdrawal must be taken by Dec. 31, 2018. The amount will equal the Dec. 31, 2019, account balance divided by 35.0 (the single life-expectancy figure for someone age 48 minus 1.0 because you are now a year older), and this pattern will continue on for each subsequent year as long as you live or until the inherited account is completely drained. The same drill applies if you inherit Uncle Henry’s Roth IRA or Simplified Employee Pension (SEP) account.
In the death-before-the-RBD scenario, you do have one other option: the so-called five-year rule. It simply requires you to completely liquidate the inherited account by no later than Dec. 31 of the fifth year after the year the original account owner dies. Until that date, you can withdraw as much or as little as you wish. For example, if Uncle Henry died in 2018, you’d have until Dec. 31 of 2023 to liquidate his account and pay the resulting tax hit, under the five-year rule. But if you don’t need all that money over the next five years, following the five-year rule isn’t the tax-smart choice. Why? Because you’d forgo the many additional years of tax-deferral advantages allowed if you choose to gradually liquidate the account over your life expectancy (as in the earlier Example). In some cases, however, beneficiaries must follow the five-year rule, because the IRA trust document requires it or because the now-deceased account owner specified it.
Scenario 2: IRA owner dies on or after RBD
In this case, follow the procedures explained above in Scenario 1. In other words, you must take your initial required minimum withdrawal by Dec. 31 of the year after the year the account owner dies using your own life expectancy to calculate the minimum withdrawal amount. The only difference in this scenario? The five-year rule isn’t an option. You must also arrange to take the deceased account owner’s year-of-death mandatory withdrawal by Dec. 31 of that year. That amount is calculated as if the account owner were still alive at the end of that year. Once again, the same rules apply if you inherit a Roth IRA or SEP account.
This story was updated on March 25, 2019.
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