IRS Tardy on Inherited IRA Rules
Question: When my father died in October, 1980, my mother inherited his IRA. She had read somewhere that the beneficiary of an inherited IRA has five years from the date of death to take a distribution from that IRA without having to pay a 10% penalty for premature withdrawal of funds. So, she took a premature withdrawal from that IRA--in November, 1985. I can’t find any reference to the rule she remembers. Is there a penalty or not?--M. L. R.
Answer: Tell your mother she should feel very lucky. It appears that she has narrowly escaped getting hit with a stiff penalty. And all because the IRS is smarting over its own tardiness in issuing regulations on some 2-year-old laws governing IRAs and other retirement accounts.
At the time of your father’s death, the rule governing distributions of money from IRAs was pretty much as your mother remembered it. A surviving spouse who inherited an IRA could choose to treat the IRA either as her own or as the inherited property of her husband.
If she chose to treat it as her own IRA, she would have been bound by the same rules applicable to any IRA she had opened herself. That is, she would be penalized for a premature distribution if she withdrew money from the account before she turned age 59 1/2. The only circumstances in which money can be withdrawn prematurely without penalty from an IRA are the death or disability of the owner.
Conversely, if she chose to treat it as her husband’s IRA, she had five years to begin withdrawing money from the account. After that, a 10% penalty was assessed. The entire account didn’t have to be drained in five years, but distributions had to have begun.
Under those rules, your mother could have chosen to do nothing--in which case she would have been deemed after five years to have opted to have this treated as her own IRA. In other words, she could withdraw money from the account any time she wanted as long as she was at least 59 1/2 years old, and incur no penalties.
If she chose instead to treat it as your father’s IRA, she had until October, 1985, to begin withdrawing money from the IRA. From your description, that is what she did. But she did it one month late. Thus, she ordinarily would have been subject to a penalty. But last month, the IRS issued a notice that seems to offer your mother a break.
In the notice, the IRS extended the time available for making required 1985 distributions from IRAs and other types of retirement plans. Its chief intent was to help people who became 70 1/2 years old in 1985 and were not sure--because the IRS itself hadn’t yet issued regulations spelling out the rules--whether they had to begin withdrawing money by the end of last year, the end of this year or somewhere in between.
The confusion stems from new retirement-account laws written by Congress in 1984 and scheduled to have taken effect last year. There were dozens of them. But two are particularly germane to this situation. One states that IRA participants must begin withdrawing money from their accounts no later than April 1 of the year following the calendar year in which the participant reaches age 70 1/2, or the year he or she retires, whichever occurs later. Employees who own more than a 5% stake in their company must begin distributions no later than April 1 of the year after they turn 70 1/2--even if they retire later than that.
So, under the new rules, IRA participants who became 70 1/2 years old last year had until April 1, 1986, to start their distributions. But, because there were so many new tax laws in the pension area and so much confusion about this rule in particular, the IRS in its notice last month extended the deadline for 1985 IRA distributions to Dec. 31, 1986.
Ellen Marshall, a lawyer who specializes in pensions for the Los Angeles law firm McKenna, Conner & Cuneo, interprets the notice to include such people as your mother. The IRS, she believes, is so sensitive about not coming out with regulations sooner for these new laws and thus causing much of the confusion that it will permit taxpayers with all sorts of IRA distribution problems the right to use this extension to their advantage.
In other words, as long as she meets the distribution requirements before the end of this year, she should escape the penalty.
But you should be sure to check with a pension specialist this year. That’s because the second new law applicable to this case says beneficiaries who choose to treat an inherited IRA as the property of their deceased spouse must now either begin withdrawing money within a year of the IRA owner’s death or fully deplete the account within five years. So, someone familiar with all of the circumstances of your case should advise you whether your mother must withdraw all of the money or only part of it by next Dec. 31.
Debra Whitefield cannot answer mail individually but will respond in this column to financial questions of general interest. Do not telephone. Write to Money Talk, Business Section, The Times, Times Mirror Square, Los Angeles 90053.
