Got a question about investing, how it fits into your overall financial plan and what strategies can help you make the most out of your money? Write to me at beth.pinsker@marketwatch.com and put Fix My Portfolio in the subject line.
My wife died in 2022. We were together for 65 years. I asked our bank to have her IRA money transferred to me, as her sole beneficiary on the account and the surviving spouse. A bank representative of their IRA department told me which form to complete and how to fill it out.
My wife’s 2022 required minimum distribution was paid to my checking account at the same bank. The balance was then put in a new account with the ownership description shown as an inherited IRA. Time passed, and I took RMDs for her account and my own IRA. To my surprise, the RMD from the inherited IRA was roughly double the amount I received from my IRA, although the amounts in both accounts were approximately the same.
I discovered through research that as my wife’s sole beneficiary and surviving spouse, I should not have filled out the form for an inherited IRA, but instead rolled it over to my own IRA. I asked to have the RMD deposit reversed and reissued at the lower correct amount.
However, my bank said the IRA ownership description cannot be changed now and I have to take that larger amount.
I feel like a victim here. I followed their instructions, which were wrong. Now I have to suffer a rapid depletion of the affected IRA and pay higher tax sooner. Is there anything I can do?
Sincerely,
E.D.
Dear E.D.,
You and your wife were together a long time and this must be hard for you. I’m sorry for your loss and that you have to deal with so much paperwork.
The best you can do with big financial decisions like this is try to prepare yourself by knowing the rules that govern the transaction, but that doesn’t necessarily mean you can easily cut through the red tape involved when inheriting accounts and moving around money. It doesn’t help when you get confusing answers from the folks who are supposed to help you through it.
Unfortunately, “that happens all the time, especially as rules are changing,” says Chad Holmes, a certified financial planner at Formula Wealth based in Montgomery, Ala. “There’s a delay, even on the automated features and calculators. That could be scary if you’re relying on something like that.”
It’s also no fun to be told that the rules are the rules, but when it comes to money, financial institutions tend to very strictly adhere to IRS guidelines and other laws. That’s mostly to prevent theft and abuse, but some of it is also about collecting the proper amount of taxes.
What are the rules
When you inherit an IRA as a spouse, you have more choices than other inheritors, most of whom are required to use an inherited IRA structure. That means you have to move all the money out by the end of 10 years and take required minimum distributions annually (except when the government says that you don’t have to, like during the pandemic).
Spouses can elect to inherit the account that way, like you did, or you could choose to roll the funds into your own IRA. The formula you use to figure out how much you need to take out each year is typically the IRS’s uniform life table, which divides your account balance as of Dec. 31 of the prior year by an age factor. With a rollover, everything for you would proceed as normal, except your balance would be larger.
You’re supposed to make your choice within 60 days of inheriting the account, which has passed and is probably why your account custodian doesn’t want to make a change.
Much like Dec. 31 is fixed as the end of the tax year, “these rules are pretty much set in concrete, with little opportunity to correct,” says Nilay Gandhi, a certified financial planner and senior wealth adviser at Vanguard.
One bit of good news is that it seems like you took the 2022 year of death RMD the right way for your wife, because many families forget to do that and face penalties.
But what could you have done differently with the inheritance election f you could run back the clock — and for others just now facing this issue? It’s possible to do a back-of-the-envelope calculation as to which method is better for you before you make a choice. All you’d need for the IRS worksheets or any number of RMD calculators on the web is the prior year’s account balance, your age and your wife’s age. Or, you can contact the account custodian and have them help you run the numbers, or refer to a financial adviser or tax professional.
Whatever they tell you or you figure out for yourself, it’s best to double-check it or get a second opinion — as you have already experienced.
There’s a lot of moving pieces to these calculations, and so opinions might differ. RMD amounts will vary based on the age dynamics involved, for one thing. If the deceased was the older spouse (by less than 10 years), it might be more beneficial to do a rollover, and the opposite if they were younger.
It also matters if one or both of you are over 59 ½ and no longer face early withdrawal penalties or over the age of taking RMDs (now 73). Your general financial situation matters too, as well as your overall tax burden. For instance, if you need to withdraw more than the required amount for living expenses, the account designation will not matter much to you.
But do not feel bad that you didn’t do this on the front-end. It happens a lot. “It’s not uncommon that we see wrong decisions made,” says Gandhi.
Make the most of it
A possible solution to your red tape is to see if a different custodian would be friendly to making the change. Gandhi says you could make a few calls to see if you could move the account to a different financial institution and in the process, change the election to a spousal IRA rollover.
You can also look on the bright side of this situation. Yes, the bigger RMD means that you have a bigger tax bill right now, but there are ways you can mitigate that and also make the extra funds work for you outside of a tax-deferred IRA.
Holmes suggests that you look at your overall tax rate and your goals. If you are charitably inclined, you can use that supersize RMD toward a qualified charitable distribution (QCD). Or if you are planning to leave money for heirs and they would pay a higher tax rate than you, it might be tax efficient in the long-term to pull out even more money now. Then they could inherit your investments through a brokerage account at a stepped-up basis. “That might change the priorities,” says Holmes. “You have to think forward to the next generation.”
More Fix My Portfolio
This story originally appeared on Marketwatch
