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Friend inherited non-qualified (after tax) IRA
Old 05-27-2015, 12:35 PM   #1
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Friend inherited non-qualified (after tax) IRA

A 50-year-old married friend (father of 2 kids -- ages 17 and 10) just had both of his parents die within two months of each other. Most of their estate is in after-tax IRAs.

He has done some research and thinks these are his only 2 options:

1) Take the money as a lump sum and pay taxes on what their money earned (so if it was a $30K after-tax Non Qualified IRA, and it earned $3K, he pays taxes on the $3K, not the $30K)

2) Take the IRA in installments based on his age. So if he lives 20 more years, he just takes it in installments, so after he retires in 10 years he'll pay less in taxes those final 10 years since he won't have his exorbitant mega-corp salary.

I know there must have been others here faced with similar situations. I'm wondering if there might be some other options or strategies he could use?

FWIW, he is well-employed at a mega-corp. His wife has been a teacher 'forever' in a good school system, so she will get a decent pension. His kids are both doing great in school and will be going to college.

As his younger child will finish college when my friend is 62, he was planning to probably keep working until that kid graduates. Although, as his parents were rather frugal, depending on the size of their estate, this might precipitate an earlier-than-planned retirement.


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Old 05-27-2015, 01:06 PM   #2
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Assuming the after-tax basis is well documented, the IRS says that the cost-basis of the IRA remains with an inherited IRA (i.e. the after-tax nature stays after-tax, and he won't owe income taxes on the cost-basis) :
IRA with basis. If you inherit a traditional IRA from a person who had a basis in the IRA because of nondeductible contributions, that basis remains with the IRA. Unless you are the decedent's spouse and choose to treat the IRA as your own, you cannot combine this basis with any basis you have in your own traditional IRA(s) or any basis in traditional IRA(s) you inherited from other decedents. If you take distributions from both an inherited IRA and your IRA, and each has basis, you must complete separate Forms 8606 to determine the taxable and nontaxable portions of those distributions.
Publication 590-B (2014), Distributions from Individual Retirement Arrangements (IRAs)

There's nothing in the IRS literature I see where the RMDs from either an Inherited IRA or your own IRA are affected by having after-tax contributions. So, I would wager a guess that your friend must still take RMDs like any other inherited IRA - it's just that a vast majority of the withdrawal will be non-taxable.

So your friend can either take out 100% of the balance within 5 years, or take out RMDs from his parents' IRA starting in the first full year after their death.

Just remember that Inherited IRA RMDs take your first year divisor and then subtracting 1 ever year thereafter. many people (including me!) assume your RMD for an inherited IRA is like an RMD for a regular IRA - but it's not. Because your "divisor" for your RMD from an Inherited IRA reduces by 1 each year, after a while, you start getting huge % RMDs from an inherited IRA, to the point where you have to take out all of your remaining balance in maybe 30 years (depending on your starting age).

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Old 05-27-2015, 01:32 PM   #3
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Unless he has maxed out his retirement contributions depending on his financial situation he could make a deductible contribution to a tIRA or increase his 401k contributions for an amount equal to the gain so the net income would be nil.

So in your example 1, if he increased his 401k contributions by $3k or made a $3k deductible contribution to an IRA, then either of those would offset the $3k of income from cashing in the inherited IRA.

Depending on the amounts involved and the gain involved, he might want to do it over multiple years.
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Old 05-27-2015, 04:55 PM   #4
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I inherited a small IRA from my mom. I ended up taking RMDs within the first year and will keep doing that indefinitely or at least until I stop working. She had her IRA at Vanguard, which made it easy to transfer to me (it was actually split three ways with my two siblings).

I don't know how other companies handle inherited IRAs, but at the beginning of the year Vanguard calculates my RMD which I immediately take out of the account.

If your friend plans on continuing to work, then he might save money in taxes by taking the minimums and then cash it out fully when he retires, assuming he needs the cash.

Keep in mind that I'm assuming the parents weren't already withdrawing from the IRA. I recall that the rules were slightly different in that case, but I don't remember the details.
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Old 05-27-2015, 10:27 PM   #5
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When we inherited a "qualified" IRA we had three options.
1) Lump sum
2) A Five year payout so the tax consequences were spread over 5 years.
3) Annuitize it based on our life expectancy and start taking RMD's.

Your friends inherited IRA is "non-qualified" (after tax) and I think his decision will depend on the tax hit, his own personal tax situation and what he projects his tax situation to be down the road.

Im not sure why he thinks he has only the two options. There is a third. The five year pay out that is supported by IRS regs and as far as I know is offered by most if not all annuity companies to comply with those regs. This should have been disclosed to him by the annuity company.
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Old 05-28-2015, 05:06 AM   #6
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Originally Posted by sheehs1 View Post

Im not sure why he thinks he has only the two options. There is a third. The five year pay out that is supported by IRS regs and as far as I know is offered by most if not all annuity companies to comply with those regs. This should have been disclosed to him by the annuity company.
From the IRS prospective, is the 5 year method only relevant if the deceased IRA owner had not attained age 70.5 when RMDs would apply? Stated a bit differently, if the parent had attained age 70.5, the beneficiary would need to take their recalculated RMDs each year to avoid 50% penalty -- no 5 year grace period applies.

It is possible that the current IRA plan may have a separate 5-year distribution requirement for beneficiaries, but you would be able to transfer the IRA to your own "inherited IRA" titled account. You would need to do a direct transfer (no 60 day indirect rollovers allowed for inherited IRAs).

The "inherited IRA" account would be considered separately from his normal IRAs from here on out.


p.s. I have not had to deal with inherited IRAs yet, first hand, so please point out it out if anyone sees a flaw in my analysis.
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Old 05-28-2015, 10:02 AM   #7
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gauss….My mother had starting taking RMD's and she was 76 when she passed. We had the 5 year option. I don't think having already started RMD's has an affect on the rights to the various distribution methods to a beneficiary.
My mom passed away over 10 years ago but I can't imagine these choices have changed. Although they could have.

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