Readable articles about Inheriting IRAs, 401ks, SEPs, Roths, 403bs and other Qualified Plans are hard to come by, so when Peter Gutekunst sent me the following article which was published in the Montgomery Newspaper, I asked him if I could post it on my website. Peter agreed, and the article appears below.
Inheriting an IRA or any other form of Qualified Plan requires the advice of an experienced financial planner. I have found that most plan managers refuse to give advice to beneficiaries because an error can mean the unnecessary recognition of income tax and a lawsuit for damages. Plan managers like to invest the 401k, but are often unfamiliar with the rules that apply to inheritance. Most organizations then opt to keep their heads down, send out only the bare essential paperwork to the beneficiary and leave the beneficiary with inadequate information to make an informed decision. Without professional assistance to explain the many options, a beneficiary can easily make a costly mistake. My advice, before making any decision as a beneficiary of an IRA, 401k, SEP, 403B or any other Qualified Plan speak to an investment professional who focuses in this area and can clearly explain your options.
If you have any further questions, please feel free to contact myself through the website email, or Peter, whose contact information can be found at the article’s end.
Peter Klenk, Esq.
Peter J. Gutekunst, CFP®
Financial Planner, RJFS
Raymond James Financial Services, Inc.
When we were kids, we all must have experienced being corrected for doing what we were “told” only to learn sometimes we have to do what people “mean” and not necessarily what they “say.”
Knowing the difference isn’t always easy and in the case of inheriting IRAs and Qualified Retirement Plans not knowing the difference can be costly.
A beneficiary IRA or Inherited IRA is an account established by a retirement account beneficiary who receives the funds into the account directly from a deceased individual’s retirement account(s). The beneficiary can never make any contributions of their own money or transfer their personal retirement account assets into an Inherited IRA.
The tremendous value of establishing an Inherited IRA is that the beneficiary incurs no income tax in moving the funds from the deceased person’s account into the beneficiary account. Once the account is funded, the beneficiary needs only to take annual required minimum distributions each year based on the beneficiary’s life expectancy. This means that the tax-deferred characteristic of the retirement account can be maximized and a potentially life-long income stream can be set in motion.
Recent legislation passed in the Pension Protection Act permits qualified plans to directly transfer funds from the Plan to a non-spousal beneficiary IRA, which in the past wasn’t possible.
The problem isn’t whether or not the tax laws permit inherited IRAs and whether or not it’s possible to establish such an account. Situations can get complicated when institutions don’t exactly understand what beneficiaries are asking to have done and when beneficiaries don’t exactly understand exactly what or how to request the proper form of distribution.
What further complicates matters is that the regulations have been modified and “simplified” multiple times since 2001. This can add a layer of confusion as the terminology used by one institution to execute a transfer and the process they follow is often different from the next.
Consider this example of a daughter who recently lost her mother. The daughter was the sole beneficiary of a 401(k) plan her mother had been actively participating in until her death, a plan still held with a former employer of the mother, and a regular IRA. Three different accounts, three different representatives of three different entities who needed to help facilitate the transfers.
Step one; a financial advisor created an Inherited IRA to receive all the funds in order for the daughter to have a single, consolidated IRA for her to manage going forward. From there, she set out to implement transfers into that account.
The company plan mom had participated in just prior to her death was notified of the situation and proper documentation was submitted. In this case, it was a phone call, followed by submission of a death certificate and a simple form, which was followed by a written confirmation from the Plan that the account was in a “beneficiary” status.
At that point, a second phone call was placed and instructions were given to transfer the money to the Inherited IRA. Confirmation was made over the phone that the distribution was being executed properly. The check was not payable to the beneficiary directly and was only negotiable if placed into the new Inherited IRA account—an institution to institution transfer of funds.
The process couldn’t have gone any more smoothly and the recent Pension Protection Act provisions allowing transfers to non-spousal beneficiary accounts was followed as permitted by the new law.
Next, the former employer plan seemed to be straight forward as they sent the beneficiary a form which allowed her to complete all the details regarding the beneficiary, her new beneficiary IRA account status among other important information. The form specifically disclosed the life expectancy method and the five year-rule.
The five year rule dictates that all the funds would need to be distributed in no less than 5 years following the year after death which when compared to the life expectancy method, significantly accelerates the recognition of income taxes. If funds were left in the plan beyond the year following the year of the mother’s death, as a non-spousal beneficiary the daughter would have been forced to use the five year rule. Not understanding the meaning of that form check-block or delaying the transfer could have had serious consequences in the case of this Plan.
Despite completing the form correctly and executing the most beneficial tax-wise options for her situation which the form fully disclosed, the Plan did not distribute the funds. In following up, the administrator insisted the daughter call to confirm her intentions over the phone which further confused her since the form seemed to clearly indicate exactly what she wanted.
As the form disclosed, too long a delay in transferring the funds would have locked-in the five year rule and yet without any follow up calls to a properly executed document it is unclear what would have triggered the proper transfer of funds. The funds were subsequently transferred.
Finally the regular IRA was tackled. The daughter made the inadvertent mistake of telling the company holding mom’s IRA that as beneficiary she intended to ultimately move the money to an inherited IRA at another company. Ordinarily it is best if possible to establish Beneficiary IRAs first where ever IRAs may have been held by the deceased and then transfer those funds into a single consolidated Inherited IRA account.
Once the company learned they wouldn’t be retaining the assets, they didn’t want to be bothered with setting up a new account only to be subsequently moving the funds. Transfers can still be made this way but, the terminology used and the way exposure to taxes will be reported by the transferring and receiving companies will be different. Again it just adds a layer of confusion and an additional step in a process where a reporting mistake can be made.
With professional guidance and diligent efforts to make sure that each institution provided proper documentation, the daughter was successfully assisted in transferring all the accounts into one Inherited IRA. This one consolidated account will simplify the asset management and the annual process of calculating the annual required minimum distributions.
Peter J. Gutekunst, CFP® manages the independent firm Gute Financial, LLC in Spring House offering securities and investment advisory services exclusively through Raymond James Financial Services, Inc. member FINRA/SIPC. Peter, a Raymond James Financial Planner, can be reached for consultations at 215-643-1515 and Peter.Gutekunst@RaymondJames.com or visit www.GuteFinancial.com. Please feel free to contact Peter if you have any questions regarding your IRA. All opinions are those of Peter Gutekunst and not those of Raymond James. You should discuss any tax or legal matters with the appropriate professional.