Inherited IRA Time Bomb (Long Story)

[Southern Geek]

Those of you who have dealt with an Inherited (Non-Spousal) IRA are probably familiar with the tax minefield that one has to negotiate to ensure the beneficiary correctly sets up an account so as to minimize taxes and stretch IRA RMDs over their lifetime. One misstep, and BOOM!, you can end up (even retroactively) paying tax on the entire assets of the IRA in the year of the decedent's death. I just recently discovered that it is possible to believe that the minefield has been successfully traversed, only to have a mine explode 1.5 years later. Here is the story...

I have 2 adult children who were the beneficiaries of an IRA owned by their grandmother who died in Summer of 2013. The children wisely elected to split the IRA and have the original custodian transfer the assets into beneficiary accounts that they would set up at the institution where they do their banking. I accompanied them to bank when they went in to setup the accounts as I done the paperwork for the original custodian and could ensure the transfer done correctly. The bank already had the checks which were sent directly to the bank by the original custodian. The checks were correctly titled to show that the funds were from an Inherited IRA ('Decedent Name' IRA FBO 'Beneficiary Name'). Their IRAs were set up to receive the funds and the checks deposited. At the time, the associate who set up the accounts informed my children that though the account would appear as generic 'IRA' in their statements, within their system the IRAs were appropriately registered and coded as Inherited IRAs. Everyone leaves the bank thinking the minefield is behind us. This is Fall of 2013.

Since the original owner of the IRA had taken a RMD in year of her death, my children would not need to take any distributions from the account until their first RMD at the end of 2014 (by 31DEC of year following death of original owner). They take their distributions end of last year.
Last month, I get a call from one of my children asking if I knew why the tax software she was using kept insisting she owed an early withdrawal penalty on her IRA distribution. I tell her there must be an error, as distributions from an Inherited IRA are an exception to the EWP. Since the child lives nearby, I got with her to figure out where the error was. The error was in the 1099-R she received from the bank for her IRA RMD. Box 7 of the form should have had a '4', but instead it had a '1'. (A '4' is always used to code distributions from an Inherited IRA. It indicates an exception to the EWD due to death of original owner. A '1' would be code used for early withdrawal from a Traditional IRA indicating penalty applies.) I told her that the bank had provided her with an incorrect 1099-R and that she should contact the bank and request a corrected 1099-R. [I contact my other child who tells me the same error is on their 1099-R.]
A week or so later she stops by the bank to request a corrected 1099-R. And the last tick on the time bomb expires. The associate tells my daughter that she has no Inherited IRA. The system shows that she has a Traditional IRA that was set up in late 2013, but no Inherited IRA. My daughter tells her she is wrong. The associate tells her that she would check their records and contact daughter later in the day with the results. Later that day, daughter receives call that bank has no record of her having set up the IRA as a Inherited IRA. Therefore a corrected 1099-R could not be issued.
I get involved because if the issue was not corrected, the IRS could consider the original transfer of assets as a distribution that would be taxable to them when the transfer occurred, resulting in the filing of amended tax returns for 2013 that included additional taxes and possible penalties. That evening I post a summary of what has happened to a forum monitored by experts in IRAs. The consensus response was the the bank had made a error when they set up the account; and the bank could/should be able to correct it if we could get the right people involved. One of the responses included a link to an article written by IRA Expert Denise Appleby that covered exactly our situation and the steps to correct it without running afoul of the IRS.
The next day I'm on the phone with the associate that my daughter talked to previous day, and explain that there must be an error in the configuration of the account. I informed the associate that I had paperwork from the original custodian showing that a trustee-to-trustee transfer of the decedent's IRA to my children's IRA had occurred, even if they couldn't find it in their records. I sent the associate the documentation along with a link to Denise Appleby's article that outlined how the bank could correct the error.
I have to give kudos to the associate. After talking with me, the associate believed something was amiss and took ownership of the problem. The associate contacted the branch manager, and together they got with their tax and IRA departments, and determined that the IRA was no longer correctly 'coded' in their system. They fixed the error and issued corrected 1099-Rs to my children the very same day.
Fortunately, my children bank with a regional FCU that is known for great customer service. I shudder to think of what it would have taken to get a national bank to fix the error. OTOH, their 'small size' may have been the root cause of the issue. It turned out that the software platform the the FCU uses to support its operations cannot distinguish between a regular IRA and an Inherited IRA. Within this platform, they are coded the same. So to handle the few Inherited IRAs in their system, an electronic note is attached to the IRA account that informs any associate that handles a distribution from the account, that account is an Inherited IRA and that a Code '4' is to be used on the distribution form (which is used by their tax department to generate the 1099-R). It is an entirely manual process. For reasons unknown, this note was missing from my children's IRA accounts. It could be that the associate who originally set up the account forgot to attach the note. Possible the notes were there, but did not survive a migration to a new platform in mid-2014.
The thing is, I don't know how we could have prevented a problem like this from occurring. You can think you did everything right only to find out way late that it's not. When the accounts setup for the transfer from the original custodian, there was no way for us to know that it was not done correctly (or for us to know that the 'code' was lost in the interim). We didn't know the platform the bank used; whether the platform supported Inherited IRA accounts directly; the bank's processes, etc.; and did't have access to verify ourselves. Nothing in the client facing records indicated the problem. I'd be interested if anyone on this forum who has experience with Inherited IRAs at National banks or firms can tell me if their client facing records (paper statements, Web account access, etc.) indicate that the IRA is inherited.
I post this as a cautionary tale that fortunately for us had a good outcome. Meanwhile, I've told my children that for all future distributions they need to ensure the associate reads the note and codes a '4' on the Distribution Form. If that doesn't happen, stop the transfer, and ask for help.

[powerplay]

I have an inherited IRA that I transferred to Vanguard. It shows as an inherited IRA on the paperwork. If your local FCU can't handle the situation perhaps consider one of the larger institutions like Fidelity or Vanguard.

[Htown Harry]

Nice job staying on top of this for your kids, SG.

Until reading this, I might have assumed complex account titling or trustee situations that could stump a bank's software. But tracking plain vanilla inherited IRAs with electronic sticky notes? No way.

FWIW, Vanguard has been very easy to deal with in both setting up and maintaining inherited IRAs.

Getting the money transferred out of the original accounts? Not so much.

[scrinch]

I'm glad that this ended up working out well for your kids. That small slip on the part of the credit union could have cost a pretty penny!

I had to deal with my father's IRA when he passed away in 2001, and because of this type of potential problem, I just left the inherited IRA at Fidelity where he had his original IRA. My sister had her share transferred to a new Inherited IRA account at Schwab and has had no problems. Having to take distributions from the IRA each year has educated me about RMDs, and motivated me to look into Roth conversions for my own IRAs in the first 10 years or so after after I retire next year. Otherwise at age 70.5 I will be required to make some pretty hefty distributions and pay taxes at an undesirable rate.

[scrabbler1]

My friend's mom passed away in late 2012 and the IRA Admin (Morgan Stanley Smith Barney) split the account into 2 parts, one to him and one to his sister after taking the RMD which their mom hadn't yet done.


I have most of the paperwork involving this transfer as well as my friend's subsequent transfer of the Inherited IRA from MSSB to Fidelity later in 2012. I checked out a few things, not limited to what the OP wrote. First, on his 1099-Rs for Inherited IRA RMDs, Box 7 is checked as 4 for its distribution code, so Fidelity got that right. Also, on the MSSB 2012 statement, it had as the title of the account "IRA BDA," where the BDA stands for "Beneficiary Designation Account," a term relevant to an inherited IRA. OP, is there anything in the original paperwork which mentions "BDA"?


I suppose big institutions such as Fidelity and MSSB process lots of Inherited IRAS all the time, so these are routine transactions they won't get wrong. Everything has gone smoothly with his inherited IRA and the RMDs since late 2012, I am happy to say. I hope everything goes smoothly going forward for you and your children, too.

[walkinwood]

Thanks for the writeup - good job getting it resolved.

[audreyh1]

That was informative. The takeaway for me is to work with a company that does a ton of these.

[38Chevy454]

I fortunately navigated the mine field without problems, on small inherited IRA from my father. It was split 1/3 to each of 3 kids (about $40K each), and was with Fidelity. Fidelity transferred them as BDA accounts, and then i was able to switch the effective date the RMD percentage is calculated to be me and sister's ages. Still requires RMD to be done since based on father's age, but the amount is based on kid's age. So it helps keep the tax consequences down and lets it try to grow more like a normal IRA account, less the smaller required RMD.

Also, my 1099-R are coded 4 in box 7. Always have been since it became an inherited account.

[seraphim]

DW also has a non-spousal inherited IRA. Set up an account with Vanguard over the phone, transferred it, and they figure the RMDs and distribute them to our bank account. VG is very conscientious - no problems whatsoever.


Sent from my iPad using Early Retirement Forum

[GrayHare]

Quote:

Originally Posted by audreyh1 That was informative. The takeaway for me is to work with a company that does a ton of these.

Very true, but tough to know in advance. I learned the hard way PNC is not experienced with IRAs, and though years have elapsed PNC has yet to fix admitted IRA errors.

Places like Fidelity and Vanguard tackle enough that they can get IRAs correct.

[Texas Proud]

Quote:

Originally Posted by audreyh1 That was informative. The takeaway for me is to work with a company that does a ton of these.

Yes... I would not trust a bank, even a large one, to get this right... no way for a small bank or any CU... their main function is deposit accounts and loans... keeping up with IRA rules does not make them much money....

I would go with a brokerage or mutual fund company where this is where they have expertise in these things... (well, for me it would be Vanguard)...

[Southern Geek]

Quote:

Originally Posted by powerplay I have an inherited IRA that I transferred to Vanguard. It shows as an inherited IRA on the paperwork. If your local FCU can't handle the situation perhaps consider one of the larger institutions like Fidelity or Vanguard.

Over a year ago, I had a conversation with both children and recommended they transfer the IRAs to Vanguard. At the time, neither seem interested even though they both already have Roth IRAs at Vanguard. After this incident, I plan to bring it up again.

[powerplay]

Quote:

Originally Posted by Southern Geek Over a year ago, I had a conversation with both children and recommended they transfer the IRAs to Vanguard. At the time, neither seem interested even though they both already have Roth IRAs at Vanguard. After this incident, I plan to bring it up again.

Good for you. I would fear that the story you told could become an annual event at that FCU because of their inadequate system and the manual flagging.

[Southern Geek]

Quote:

Originally Posted by scrabbler1 I have most of the paperwork involving this transfer as well as my friend's subsequent transfer of the Inherited IRA from MSSB to Fidelity later in 2012. I checked out a few things, not limited to what the OP wrote. First, on his 1099-Rs for Inherited IRA RMDs, Box 7 is checked as 4 for its distribution code, so Fidelity got that right. Also, on the MSSB 2012 statement, it had as the title of the account "IRA BDA," where the BDA stands for "Beneficiary Designation Account," a term relevant to an inherited IRA. OP, is there anything in the original paperwork which mentions "BDA"?

I don't have the original paperwork from when the accounts were set up as that went to the children. However, while talking with one child on the phone, she said she had found the original paperwork and that it was 2 forms. 1 was a standard form for opening a IRA account that had her name, address, SSN, account #, etc. She said she didn't see anything on the form that could indicate that the IRA was Inherited. The other form was for beneficiary designation. She did remind me that the associate filled out both forms when we met to set up the accounts. The associate insisted on filling out the forms to ensure they were correct. Since neither I or my children knew what should be on the forms for opening an Inherited IRA at the FCU, we had to rely on the associate.

[Southern Geek]

Quote:

Originally Posted by audreyh1 That was informative. The takeaway for me is to work with a company that does a ton of these.

I agree. If I only I knew then what I know now. The associate who helped us resolve the problem told me that in 7 years of working at the FCU, this was the first time that they personally had done anything with an Inherited IRA account although they had a lot of experience with regular and ROTH IRAs. The associate did not know, until helping resolve this incident, that an 'electronic note' attached to the account was the only way for system to identify the IRA as Inherited. I think the associate was as surprised as I was.

[Southern Geek]

Quote:

Originally Posted by powerplay Good for you. I would fear that the story you told could become an annual event at that FCU because of their inadequate system and the manual flagging.

That's my fear too. My other fear is that since the FCU has no record of accounts set up as an Inherited IRA, that there could be trouble with recreating the title if children decide to transfer the account somewhere else. The associate stated that the 'electronic note' added to the accounts includes the name of the original owner (decedent) along with the distribution and coding instruction, but I've not seen the note so I have to their word for it.

[gcgang]

Do you think they have any clue how to compute the Bene IRA RMD?


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[Southern Geek]

Quote:

Originally Posted by 38Chevy454 Also, my 1099-R are coded 4 in box 7. Always have been since it became an inherited account.

I think this may be the one thing that really bothered me about this incident. The FCU ought have a way for a client to verify that an Inherited IRA is correctly set up other than getting an incorrect 1099-R 1.5 years later. There should be something on the client side of the interface that indicates the IRA is Inherited (like the BDA designation prior posters have mentioned). Use of an electronic note that can't be seen by the client just seems too fragile.

[Southern Geek]

Quote:

Originally Posted by gcgang Do you think they have any clue how to compute the Bene IRA RMD? Sent from my iPad using Early Retirement Forum

No. The children have to compute their RMD each year and then go to FCU to withdraw that amount from their account. It is not done for them automatically by the FCU.
The associate I worked with to resolve this issue did not even know that beneficiaries of Inherited IRA have to take a RMD each year.

[ExFlyBoy5]

Does this CU also still use AOL dial up internet and Commodore 64 terminals? They would be fired, immediately.

Sent from my mobile device so please excuse grammatical errors.