The Worker, Retiree, and Employee Recovery Act of 2008 suspended Required Minimum Distributions (RMDs) for 2009, giving many IRA investors a much-needed extra year of tax-deferred growth. After a one-year RMD layoff, however, investors must be careful not to miss a required distribution in 2010 and owe a sizable penalty. Those who inherited an IRA in 2009 are particularly susceptible.
Inherited IRAs Have Required Minimum Distributions
Most original owners of Traditional IRAs understand and plan for the fact that they’ll need to take RMDs beginning the year after they reach age 70 ½. Investors who inherit a Traditional IRA, on the other hand, are much more likely to be blindsided by the RMD requirement, either because they’re too young to have other RMDs, or because no one explicitly makes them aware of the rules when they inherit their accounts. While surviving spouses have the option to transfer ownership of the IRA to their own name and take distributions on their own schedule, non-spouse beneficiaries don’t have it so easy. According to IRS Publication 590, non-spouse beneficiaries must either:
1) distribute the entire Inherited IRA by the end of the fifth year following the owner’s death or
2) begin taking distributions on the Inherited IRA based on their own life expectancy in the year following the owner’s death.
The penalty for failing to take a required distribution is a whopping 50% of the distribution amount.
Sample RMD Calculation for Non-Spouse Beneficiary
The RMD calculation is best explained with the following example, taken directly from IRS Publication 590:
Your father died in 2009. You are the designated beneficiary of your father’s traditional IRA. You are 53 years old in 2010. You use Table I [from Appendix C of Publication 590] and see that your life expectancy in 2010 is 31.4. If the IRA was worth $100,000 at the end of 2009, your required minimum distribution for 2010 would be $3,185 ($100,000 ÷ 31.4). If the value of the IRA at the end of 2010 was again $100,000, your required minimum distribution for 2011 would be $3,289 ($100,000 ÷ 30.4). Instead of taking yearly distributions, you could choose to take the entire distribution in 2015 or earlier.
*Note that the example uses a life expectancy factor of 30.4 in 2011. This was obtained by subtracting 1 from the 2010 factor, not by looking up a new factor in Table I. You would continue to use this method in future years (use a factor of 29.4 in 2012, 28.4 in 2013, etc).
Inheriting an IRA is a blessing, but it also comes with responsibility. If you inherited an IRA in 2009, don’t forget to take your Required Minimum Distribution by December 31, 2010 to avoid a stiff IRS penalty. Also remember that IRA distributions are counted as ordinary income for tax purposes. If you’d like to spare your heirs from future RMD calculations, you may want to consider Roth conversion for your remaining IRA accounts.
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