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Caveat to Taxation of Inherited IRA Distributions

by Phil Levin, Esq. on May 1st, 2017

Distributions from an inherited Individual Retirement Account (IRA) generally are taxable in the year the distributions occurs. However, Internal Revenue Code Section 402(c) provides for an exception: Distributions rolled-over to a separate retirement plan account established for the beneficiary. There is a caveat to this exception, which was recently highlighted in Letter No. 2016-0062 from the Internal Revenue Service.

IRS Letter No. 2016-0062 pertains to an attempted roll-over implemented by a surviving son from his deceased father’s retirement account. The decedent’s accounts were from employee retirement plans, to be paid to a non-spouse. Under IRS Code 402(c)(11), retirement plan account distributions for deceased employees, that are transferred to a retirement account established for a non-spouse beneficiary, may be eligible for the income tax-free rollover. However, the IRS noted that the accounts in question in that case were not rolled-over into another retirement account established for the son’s benefit, but rather were paid directly to the son, and thus did not qualify for the Section 402(c)(11) rollover exception. This was a serious and irreversible error since IRS rules and regulations do not provide a “60-day Put-Back Rule” for payments made directly to non-spouse beneficiaries of tax-deferred retirement plan accounts.

Individuals who are interested in the long-term growth and preservation of their retirement plan assets, which distribute to loved ones upon their passing often implement a Retirement Plan Inheritance Trust, which is also known as an IRA Beneficiary Trust. These trusts may be especially useful for you and your clients in order to protect tax-deferred assets from the potential claims of the surviving spouse and children from creditors claims, including loss of property in the event that a child’s marriage dissolves, as well as from other creditor issues which often arise throughout the lives of children.

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