Friday, October 25, 2013

Inheriting an IRA? Here's What You Need To Do!

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When writing my post on Required Minimum Distributions, I found that Pub 590 Rules for RMDs from Inherited IRAs were completely different and very extensive thus needing it's very own blog post. 
The person who receives an IRA when the owner dies is known as a beneficiary. Beneficiaries must include any taxable distributions in their gross income. 

Rules To Remember:  

A. Spousal IRA or NOT: If you inherit from a spouse, you can do one of 3 things:

  1. Treat it as your own, by designating yourself as the account owner.
  2. Treat it as your own by rolling it over into your IRA/ qualified employer plan/ qualified employee annuity plan/ tax-deferred annuity plan/ a deferred compensation government plan. 
  3. Treat yourself as the beneficiary. 
You will have chosen to have treated the inherited IRA as your own, if you made contributions into it including rollovers; did not take RMDs from it till the required age; if you are the sole beneficiary of the IRA & you have an unlimited right to withdraw amounts from it. 

Pic Courtesy: Google
If the inheritance is from someone who is not a spouse, you CANNOT treat the IRA as your own. The only recourse is then NOT TO TOUCH it, but to make a trustee to trustee transfer into an IRA that has been designated as an inherited IRA, for example, "Poppa Blue-eyes, deceased, inherited for the benefit of Sonny Bono, beneficiary". 

You will then not to have pay taxes on the assets in the IRA, until you receive distributions from it. You must take distributions under the rules for distributions applicable to beneficiaries. The method to do so & rules are explained very well by Vanguard hereThe custodian can be asked to split the inherited IRAs into separate accounts if there are more than 2 beneficiaries. 

B. Beneficiary Forms:  The form on file with the custodian of an IRA CONTROLS who inherits the IRA AND its ability to be taken over the life of the beneficiary. If people other than a spouse are named as heirs, they must begin taking distributions from the account by Dec. 31 of the year after inheriting, but these can be drawn out over the expected life spans of the beneficiaries. They too can enjoy years of income-tax-deferred growth in a traditional IRA or tax-free growth in a Roth IRA by making proper arrangements with the custodian. 

If your inherited IRA had named both primary and alternate individual beneficiaries (For Example: Spouse as primary and kids as alternates OR kids as primary and grand-kids as alternates), you, the primary beneficiary then have the option of “disclaiming” or turning down the account, enabling it to pass to the younger alternate. The custodians resort to their default policy if there is no beneficiary on file & send the funds directly to the estate. Different brokerage firms have different policies. 

An important point to remember is that a beneficiary form overrides a will. 

C. Estate As Beneficiary:  Some name their estate as their IRA beneficiary, or inadvertently do so by failing to select a beneficiary. This cuts short the IRA's tax deferral. If the IRA is a Roth IRA, all funds must be withdrawn within five years. For a traditional IRA the same rule applies unless the former owner was already 70 1/2–the age at which a traditional IRA owner must begin cashing out. In that case the distribution rate for the heir is based on the age of the person who died.

D. Traps and Pitfalls:  
  • If the late IRA owner was 70 1/2 or older, beneficiaries must make sure the owner’s mandatory distribution for the year of death is withdrawn before doing anything else. 
  • When non-spousal beneficiaries take their own payouts, check if the estate paid estate tax, they may be able to take an itemized deduction to offset some IRA income. (Pub 559)
  • For non-spousal beneficiaries again, the minimum distribution is calculated differently than for your own IRA. You take the balance on Dec. 31 of the previous year and divide it by your life expectancy listed in the IRS’ “single life expectancy” table, rather than the table used by IRA owners. The next year you use the same life expectancy, minus a year. (You use a different table for yourself every year.) 
  • Be mindful of key dates & deadlines outlined here.  

Bibliography: Publication 590; Publication 559;; Estate Planning Smarts by Deborah L Jacobs. 

As always, read my disclaimer here. Please consult a qualified tax professional for your unique tax needs. 
More of my contact information is on my website,

Monday, October 21, 2013

The ABCs of RMDs: Cracking the Code on Required Minimum Distributions

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As you gear up for your year end planning, let me ask you this-did you or someone you know turn 70 years old this year? If you did or they did, you know it is the year you hear the buzz of the words "Required Minimum Distributions" aka RMDs

What are RMDs? 

The Internal Revenue Service (IRS) defines it as "Required Minimum Distributions generally are minimum amounts that a retirement plan account owner must withdraw annually starting with the year that he or she reaches 70 ½ years of age or, if later, the year in which he or she retires. However, if the retirement plan account is an IRA or the account owner is a 5% owner of the business sponsoring the retirement plan, the RMDs must begin once the account holder is age 70 ½, regardless of whether he or she is retired."

When Do They Have To Be Taken?

You must take your FIRST required minimum distribution for the year in which you turn age 70½. However, the first payment can be delayed until April 1 of the year following the year in which you turn 70½. For all subsequent years, including the year in which you were paid the first RMD by April 1, you must take the RMD by December 31 of the year.

Let us break that down for you:

For year 2013, if you were born on or before June of the year 1942, you are eligible to take an RMD. You have to take RMDs from:
  • All employer sponsored retirement plans, including profit-sharing plans,
  • 401(k) plans, 403(b) plans, and 457(b) plans. 
  • Traditional IRAs and IRA-based plans such as SEPs, SARSEPs, and SIMPLE IRAs.
  • Roth 401(k) accounts if the Roth 401(k) is inherited. 

How Do We Calculate RMDs?

An RMD is calculated for each account by dividing the prior December 31 balance of that IRA or retirement plan account by a life expectancy factor. This factor is published by the IRS in Tables in Publication 590, Individual Retirement Arrangements (IRAs)
You would use the:
  • Joint and Last Survivor Table if your sole beneficiary of the account is your spouse and your spouse is more than 10 years younger than you;
  • Uniform Lifetime Table if your spouse is not your sole beneficiary or your spouse is NOT more than 10 years younger; and
  • Single Life Expectancy Table if you are a beneficiary of an account.
You can also use an online RMD Calculator such as this one from Charles Schwab or talk to your tax professional. 

How to Take an RMD? And "dit and dat": 
Pic Courtesy: Google Images
  • The IRA Custodian or the plan Administrator may calculate the RMD to be taken by you, but you are ultimately responsible for taking the correct RMD based on your total investment in all plans. 
  • You can withdraw more than the RMD. 
  • If you are an IRA or a 403(b) owner: You must calculate the RMD separately for each IRA that you own, but you can withdraw the total amount from one or more of the IRAs.
  • If you are the owner of 401(k) or 457(b) Plans: the RMDs have to be taken separately from each of those plan accounts. 
  • You cannot roll over the RMD into another tax deferred account.
  • You will be taxed on this distribution at your tax rate. To the extent the RMD is a return on basis, it is tax-free.  
  • You cannot apply the excess distribution of one year to the next. 

Penalties and Other IRS Favorites: 

  1. If you fail to withdraw an RMD; fail to withdraw the full amount of the RMD; or fail to withdraw the RMD by the applicable deadline; the amount not withdrawn is taxed at 50%. 
  2. You should then file Form 5329 {Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts}, with your federal tax return for the year in which the full amount of the RMD was not taken.

If the magic number seven-zero is fast approaching, you need to sit down with your tax professional and/ or your financial planner and talk about your options. If you are going to to end up paying a lot of taxes on your RMDs, maybe Roth conversions are an option for you. Planning, planning, planning is the answer to the cracking the code of the RMDs. 

Bibliography:; Pub 590;

As always, read my disclaimer here. Please consult a qualified tax professional for your unique tax needs. More of my contact information is on my website,


Thursday, October 17, 2013

The Science Behind A Home Mortgage Interest Deduction!
Somewhere around summer, we noticed a spike in home sales. It seemed like people who had been waiting to sell were finally convinced that home values were desirable enough. The question I get most often from people looking to either buy their first home or upgrade is, if the home mortgage interest deduction on their taxes is a factor they should consider when purchasing. 

My answer to them is to think about their cash flow and not about the deductibility of  the home mortgage interest. What does that mean? Let me explain the "Science" behind the Home Mortgage Interest Deduction. 

What Is A Deduction?
In tax parlance, a deduction is expenditure that lowers income which is taxed. These are
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offered to taxpayers, 

  • By way of the Standard Deduction which is a fixed amount based on one's filing status (2013: Single or Married filing separately: $6,100, Married filing jointly or Qualifying widow(er): $12,200, Head of household: $8,950) OR 
  • By way of Itemized Deductions, taken on Schedule A on your Form 1040. The Home Mortgage Interest Deduction is a part of your Itemized Deductions which include among other things, your property taxes, charitable contributions, out-of-pocket medical expenses above a threshold etc. 

How Does This Work 
with Your Cash Flow?
One would take all the items available on Schedule A and look at the total expenditure on that. If that was more than the Standard deduction for your filing status, it would be beneficial to you to itemize. For example, if you were filing a joint return with your spouse, your total expenses would have to be more than $12,200. 

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For simplicity's sake, let's assume that you are able to itemize and your income was around $80,000, and you were filing single, you would fall into the 25% tax bracket. If your mortgage interest was $2000, you would get a benefit of $500 which is 25% of $2000. The rest of the $1,500 was still a expense that you will not be able to recuperate on your taxes. 

Crunching your numbers then, based on the calculator at, you take a 30 year mortgage of $200,000 at a 5% interest rate, we see that first year of that mortgage, which is the year with the greatest amount of interest paid, you would pay $6,184.17 in interest. For a single person in the above example, this is just around the mark where you could itemize. But you are still only getting a benefit of 25% of this $6184.17 that you spend on mortgage interest. You would have to have to hit another $6,100 in total expenses in the other categories on top of the mortgage interest to take FULL advantage of it as a deduction. 

The Bottom Line Being: 
The mortgage interest is NOT automatically deductible. In some cases, it may be partly deductible or not deductible at all. We should NOT assume it to be a benefit of home ownership, it is cash spent out-of-pocket that has to be accounted for. Maybe a tax deduction only makes it slightly cheaper. 

Please read my disclaimer here. Please consult a tax professional for your unique situation. For any questions regarding this or other tax matters, please contact me via Email: