In an important private letter ruling, the IRS denied a claim to have IRA funds that were moved to a non-IRA account back into an IRA. While this doesn’t provide precedent and cannot be cited, it does show guidance for an Inherited IRA transfer. In short, if you want the tax benefits of the plan, make sure the funds remain in there. If you wish to move it to another custodian for example, do so carefully to avoid potential income tax implications.

The Facts

A tax payer (name withheld) had inherited an IRA from a spouse. The surviving spouse then named a trust as the new beneficiary of the IRA. He or she then named their children as trustees and beneficiaries of that trust. When the surviving spouse later died, the IRA became an Inherited IRA for the benefit of that trust.

The beneficiaries wished to trade stocks with the IRA. However, the custodian told them that they could not do that. Instead, they would need to transfer the funds into another account in order to trade. Which, in turn, they did. The new account was a non-IRA account.

After a few months, a request was sent to reverse the transfer to the new account. They wished to transfer those funds back to an Inherited IRA account, for the benefit of the trust.

In addition, they sought to not include funds transferred in their gross income, and they wanted to move the funds to a different Inherited IRA, not back into the original plan.

Understanding Inherited IRAs

Inheriting an IRA can be a complex process due to unique rules and potential tax implications. An inherited IRA, also known as a Beneficiary IRA, is an account opened when someone inherits an IRA after the original owner dies. The beneficiary may be a spouse, relative, estate, or trust. Any type of IRA can be opened as an inherited IRA, including traditional IRAs and Roth IRAs. Inherited IRAs come with specific rules and tax implications that beneficiaries need to understand to manage the account effectively and avoid unnecessary taxes.

The IRS Ruling

Once the surviving spouse passed, the IRA became an Inherited IRA for the benefit of the trust. Those assets are not permitted to be rolled over. The only way to move those funds from one custodian to another is a trustee-to-trustee transfer. The funds move directly from one custodian to the other. This is the only way to maintain the tax advantages of the plan.

In this case, the funds were moved out of the IRA and transferred to a non-IRA account. Because of this, they were considered distributed from the IRA and cannot then be put back into any IRA, meaning the beneficiaries would have to pay taxes on the distributed amount.

Following IRS rules, the distribution from the IRA must be treated as taxable income for the year in which it was taken. Therefore, all the funds withdrawn from the IRA will be considered as gross income for tax purposes.

Beneficiary Options

Beneficiaries of an IRA have several options when inheriting an IRA. If the beneficiary is the spouse, they can treat the inherited assets as their own by rolling over the Inherited IRA into his or her own IRA. This allows the surviving spouse to continue growing the assets tax-deferred.

If the beneficiary is a non-spouse, they must roll the inherited assets into an Inherited IRA. It’s crucial to ensure that the registration type of both IRAs is the same, meaning traditional to traditional or Roth to Roth. Additionally, if the original account owner was taking Required Minimum Distributions (RMDs), the RMD due for the year of death must still be taken by the beneficiary. Read on for more information.

Inherited IRA Transfer Rules

As mentioned, Inherited IRAs are subject to RMDs, which must be taken annually. The RMD rules depend on the type of beneficiary and the age of the beneficiary. Eligible Designated Beneficiaries (EDBs) can take RMDs over their life expectancy or the life expectancy of the account holder. Non-spouse beneficiaries who are not EDBs must take RMDs over a 10-year period. Beneficiaries who are disabled or chronically ill may be able to take RMDs over their life expectancy, providing more flexibility in managing the inherited assets.

Inherited IRA Transfer Guidance

It’s important to remember there are different rules for Inherited IRAs based on if you are the spouse or non-spouse of the decedent. The SECURE Act has introduced new distribution rules that beneficiaries must follow. A spouse can assume the IRA for his or her own. However, a non-spouse cannot, and therefore must follow the IRS rules to a tee.

Since the custodian of the IRA would not allow stock trading within the plan, the only play here was to do a trustee-to-trustee transfer to a new IRA custodian. Once the funds were moved from the IRA, all tax benefits of the IRA were lost.

Since it was a non-spouse beneficiary, they were allowed to keep the IRA intact for ten years before having to withdraw from the plan completely. That’s a decade of tax-deferred wealth that was lost.

What Should YOU Do About Required Minimum Distributions?

When you inherit an IRA and wish to invest with it, you must leave those funds in the plan. When you inherit an IRA, you must open an Inherited IRA to manage the funds properly. If the IRA custodian does not offer you such choices, you must do a trustee-to-trustee transfer of the funds to a custodian, such as IRA Financial, of your choosing. At no point, can you touch the funds in the IRA. Further, you cannot rollover those funds either.

In many cases, the custodian of the Inherited IRA will not allow you to make the investments you wish to make. While an Inherited IRA can be self-directed, almost all individuals inherit a standard IRA. A Self-Directed IRA allows you to make traditional investments, such as stocks and mutual funds, and alternative investments, like real estate, gold and private businesses.

While most inherited IRAs are not Self-Directed IRAs, you can choose to transfer the IRA to a Self-Directed IRA custodian which will allow you to make the investments you wish and help diversify your retirement.

Managing an Inherited IRA Transfer

Managing an Inherited IRA requires careful consideration of the tax implications and distribution rules. Beneficiaries should consult a tax advisor or financial professional to determine the best course of action. They should also consider the following:

• Take RMDs annually to avoid penalties.
• Consider rolling over the inherited IRA into their own IRA if they are the spouse.
• Consider taking a lump sum distribution, but be aware of the potential tax implications.
• Consider converting a traditional IRA to a Roth IRA to potentially benefit from tax-free growth.
• Keep accurate records of the Inherited IRA and RMDs taken to ensure compliance with IRS rules.

Conclusion

Losing a loved one is the hardest thing in life. When finances are involved, it gets more difficult. If you are the beneficiary of an IRA, it’s important to know the best course of action for you after the original account owner died. Generally, keeping the funds in the plan to grow tax free is the smart way.

Obviously, the best way to grow those funds is by investing. If the custodian of the Inherited IRA is not for you, make sure you follow the trustee-to-trustee transfer rules. Remember, once the funds are moved from the IRA any other way, they are considered distributed. You cannot put them back into an IRA and you will owe taxes on them!

Additional Resources

For more information on Inherited IRAs, beneficiaries can consult the following resources:

• IRS Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs)
• IRS Publication 554, Tax Guide for Seniors
• IRS Publication 559, Survivors, Executors and Administrators
• IRS Publication 575, Pension and Annuity Income

By understanding the rules and options available, beneficiaries can make informed decisions and effectively manage their inherited IRAs to maximize their financial benefits. Consult a tax advisor or financial professional for personalized advice.