Inherited IRAs and transfers
This entry was posted on 2/26/2008 11:41 PM and is filed under uncategorized.
I had a client who inadvertently transfered an inherited IRA into their regular traditional Individual Retirement Account. This transfer is not "allowed" by the IRS. Inherited IRAs, that are not from a deceased spouse, have special rules that generally say that the IRA will be taxed because the custodian of the IRA is required to make taxable distributions of the IRA to its beneficiary.
The required and allowed distributions range from taking all the money right away, to over many years. Typically, people like the option of not having to take any distributions, but that isn't possible.
So the IRS wants people to keep their inherited IRAs separate from their regular traditional IRAs, since there are different rules for each.
I advised my client that the inherited IRA that was transfered was taxable and he'd have to pay taxes on it. The next question was, what to do with the combined IRA account? Could he take the inherited money out tax free because he just payed taxes on it? Another possible answer was that his new combined IRA has what we call a basis. When he took money out in the future, part of it wouldn't be taxed to balance the books on what he had already paid tax on. After some research, I couldn't find any guidance for him.
We considered a complete distribution of the account so as to avoid uncertainty. If that was done, he wouldn't pay tax on his assumed basis, or his perhaps allowed distribution of what he'd paid tax on. So I figured that the IRS couldn't have it both ways, by not allowing him both his basis and a 'corrective' distribution. This wasn't too appealing of an option, since his IRA would be gone. But it would hopefully end the problem. Fortunately, the problem was resolved. The bank (IRA custodian) took responsibility and un-transfered the money. What the bank apparently did is, transfer money from an account entitled: the beneficiary IRA of John Doe into an account entitled: the IRA of John Doe. This is something we might assume it would know not to do.
Still, I have a question for my readers. What happens to the inherited IRA money that was transfered into the normal traditional IRA account? Can it be distributed tax free the next year, is it part of the basis, or is there some answer I haven't thought of?
