Managing a Year-of-Death RMD in an Inherited IRA
The rule that you must take the required minimum distribution before doing a “rollover” does not apply to IRA-to-IRA transfers.
Question: I'm worried whether my client's IRA provider has broken a rule. Mother died in 2018 at age 83, leaving her IRA to Junior. The IRA provider is GreatBigBank. At the time of her death, Mother had not yet taken her 2018 required minimum distribution.
All cash and investments in Mother's account were transferred into an "inherited IRA" account at GreatBigBank. The name on this new account is "Junior, as beneficiary of Mother," and the taxpayer ID number is Junior's Social Security number. After that transfer was completed, Junior withdrew Mother's 2018 required minimum distribution from this "inherited IRA" account.
I know that, whenever you do a rollover from one retirement plan to another, you are required to withdraw the required minimum distribution first--before you move money into the new retirement account. That's because of the rules that (1) you cannot "roll over" a required minimum distribution and (2) the first money that comes out of a retirement plan in any year is the required minimum distribution, until the required minimum distribution has been fully distributed. Therefore until after you've taken out that required minimum distribution you cannot have an "eligible rollover distribution."
Has GreatBigBank violated this rule by moving the money into Junior's inherited IRA before paying out the required minimum distribution for 2018? Wasn't Junior supposed to take out that minimum distribution before he moved the funds from Mother's IRA to his inherited IRA?
Answer: GreatBigBank and Junior are OK, they've done nothing wrong.
You're right that you cannot do a rollover from one plan or account to another before taking the required minimum distribution for the year (if there is one). But what Junior did was not a rollover. This was simply the retitling of the account (from Mother's name to Junior's), carried out by means of an IRA-to-IRA transfer.
Let's back up a step. Normally you can't transfer an IRA to another person. But there's one big exception to that rule: Upon death an IRA is transferred from the original owner (the participant or IRA owner) to the beneficiary. That event is not income-taxable nor is it an IRS-reportable event. The minute Mother died Junior owned her account. It was transferred to him automatically.
But the IRA provider's records still showed only Mother's name on the account. The IRA provider's paperwork had to catch up with what had already happened: It had to change its records to show that Junior now owns this money.
If you read the Internal Revenue Code you get the idea that Junior is going to take over the actual same account that Mother had, just as would be true if he inherited her dining room table. But the IRA provider can't work that way. The provider can't just take the same old account agreement and cross out Mother's information and write in Junior's. It has to have a whole new account number with a new signature card, so the provider has Junior sign a new account agreement, etc.
It's like if Junior inherited Mother's car. He owns it the minute she dies, but he can't legally drive it until he goes down to the DMV and changes the registration to his name. The IRA provider is like the DMV: It doesn't recognize Junior's ownership of the account until he signs the new paperwork.
Then once that inherited IRA account is set up for Junior, the bank transfers into it all the money from Mother's IRA and closes out her account. In other words, the bank carries out an IRA-to-IRA transfer. But it's not really from Mother’s account to Junior's account; the transfer from Mother to Junior happened when she died. The "physical" transfer of assets into a new account is from Junior to Junior--from Junior's inherited account that is still under Mother's old documents into Junior's new inherited account with a new account number, documents, etc.
An IRA-to-IRA transfer is not a rollover. An IRA-to-IRA transfer is a nonevent for minimum distribution purposes or any other purpose. It's not reportable to the IRS, either as a distribution from the old IRA or as a contribution to the new IRA.
This is a long way of saying: The rule that you must take the required minimum distribution before doing a rollover does not apply to IRA-to-IRA transfers and therefore it did not apply to Junior's situation. He must take the required minimum distribution for the year of Mother's death (2018) once his new inherited IRA account is up and running and before the end of 2018.
Where to read more: Regarding the difference between rollovers and IRA-to-IRA transfers, and the requirement that a minimum distribution for the year must be distributed before a rollover can occur in such year, see Chapter 2 of Natalie Choate's book Life and Death Planning for Retirement Benefits (ebook edition; www.retirementbenefitsplanning.net). For the nonreportability of IRA-to-IRA transfers, see the Instructions for IRS Forms 1099-R and 5498 (2018), pp. 6, 19.
Natalie Choate practices law in Boston with Nutter McClennen & Fish LLP specializing in estate planning for retirement benefits.The views expressed in this article may or may not reflect the views of Morningstar. The electronic version of Natalie's book, Life and Death Planning for Retirement Benefits, is now on a new platform with expanded features. The e-book gives you the entire book in word-searchable format, plus two chapters (on life insurance and annuities in retirement plans). Visit www.retirementbenefitsplanning.net to subscribe or learn more.