Southern Geek
Recycles dryer sheets
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.
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.
