Inheriting retirement assets as a nonspouse beneficiary

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1 Inheriting retirement assets as a nonspouse beneficiary When you inherit IRAs or other retirement plan assets, you will have many planning and distribution considerations. Some of your decisions will be based on your current needs, but your ultimate goal is to maximize the value of the assets you received. Because it is important to be informed so you can make the most of this opportunity and avoid common mistakes, we have prepared this information to help you. Inheriting a qualified employer-sponsored plan If you inherit a qualified employer-sponsored retirement plan (401(k), 403(b), governmental 457, etc.) you can transfer that plan balance to an Inherited IRA. You will then have most of the distribution options available as someone inheriting an IRA, provided you complete the transfer before the end of the year following the year of death. The ability to transfer the plan assets to an Inherited IRA is also available to look-through trusts named as beneficiary. However, non lookthrough trusts, estates, and charities named as beneficiary cannot take advantage of this option. Before you transfer the employer plan to an Inherited IRA you should understand the following. You can take a lump-sum distribution, payable to you. You will owe any taxes due in the year of the distribution. However, you will not be able to roll it to an Inherited IRA or your own IRA. Also, if you want to disclaim the assets, they would need to remain in the plan until the qualified disclaimer was executed. Tax consideration Managing the amount you will pay in taxes is one of the most important considerations when deciding how to handle distributing money from the inherited account. Generally, any pre-tax amounts distributed from a Traditional IRA or employer-sponsored retirement plan will be included with your taxable income for that year. Larger dollar amounts can quickly put you into a higher tax bracket, whereas taking smaller distributions over time can help avoid a significant tax bill. Keep in mind, you do avoid the 10% early distribution penalty as a beneficiary and any post-tax amounts or qualifying Roth balances 1 would not be included in your taxable income. In many cases, it makes sense to minimize distribution of the inherited assets so you can preserve their tax-deferred features. Distribution options As a nonspouse beneficiary, you have a number of options for distributing the retirement funds you have inherited. It is important to understand the advantages and disadvantages of each option. Keep in mind, after a distribution is taken from an Inherited IRA, you are not be able to put it back. Lump-sum distribution Distributing the entire account is sometimes the simplest option since it provides immediate access to the funds. However, it may not be the best option because you could increase your tax bracket. This is because the taxable distribution of the inherited retirement assets is included as part of all the ordinary income you have for the year. You will also lose tax-advantaged compounding of those assets. Before choosing this option, it s important to consider taking distributions over a longer period of time, which can help you manage your tax bill and continue tax-advantaged potential growth. Disclaim If you do not need or want the asset, you can disclaim, or refuse, all or a portion of the assets within nine months after the account owner s death. The person who disclaims is considered to have predeceased the IRA owner so you cannot dictate who will inherit the retirement account as it generally passes to any other named primary beneficiaries or, if none, then to the named contingent beneficiary. The IRA default beneficiaries may be used if there are no valid beneficiaries on file. The defaults on an IRA with our firm are: First, a surviving spouse Second, surviving children (as defined under state law) Third, the estate Open an Inherited IRA An Inherited IRA allows beneficiaries a way to keep the funds growing tax-advantaged in an IRA while taking distributions. The account titling will always refer to the deceased IRA owner or plan participant with you listed as the beneficiary. Since you aren t the owner, you may not make contributions and cannot execute a 60-day rollover to this account. The benefit of this arrangement is that you have the option to distribute the funds over a longer period of time and are only taxed on that amount. Your distribution options are:

2 expectancy This option is available for both Inherited Roth and Inherited Traditional IRAs and is often referred to as the stretch IRA strategy. 2 You will have to take annual required minimum distributions (RMDs) over your single life expectancy on a termcertain basis. Term certain means that instead of using a new divisor from the single-life table each year you subtract one from the original divisor in each subsequent year. These RMDs will begin the year following the death of the IRA owner or plan participant. Taking no more than the RMD provides a way to keep the remainder of the money invested tax-advantaged over a longer time frame. Beneficiaries may always take more than the RMD, but by keeping the funds growing as long as possible, even small amounts may build to a substantial legacy. Five-year rule This option is available for Inherited Traditional IRAs if the Traditional IRA owner or plan participant died before meeting their required beginning date (RBD), generally April 1 after the year they turned age 70½. This option is available for Inherited Roth IRAs because Roth IRA owners are considered to have died before their RBD. With this option, the entire account must be distributed by the end of the fifth year following the year the IRA owner or plan participant died. This can help avoid having to pay taxes on the entire amount in the first year, but requires larger distributions over a shorter time. The following table summarizes the options if you inherit the funds and the IRA owner or plan participant has passed away either before or after their RBD. Remember, you will need to take distributions whether you inherit a Roth or a Traditional IRA. Nonspouse beneficiary distribution options Lump-sum distribution Disclaim expectancy Five-year rule Nonspouse beneficiary owner dies before RBD X X X X Nonspouse beneficiary owner dies on or after RBD X X X Look-through trust beneficiary owner dies before RBD X * X X Look-through trust beneficiary owner dies on or after RBD X * X Estate/non look-through trust owner dies before RBD X * X Estate/non look-through trust owner dies on or after RBD X * X** Charity owner dies before RBD X X Charity owner dies on or after RBD X X** *In some instances for a trust and estate beneficiary. **RMDs based on owner s age in year of death. Common beneficiary strategies A beneficiary who chooses wisely may avoid paying income taxes on an Inherited IRA all at once. Here a few common strategies to help you understand how to best take advantage of the inherited funds. Stretch IRA strategy Below is an example of the potential benefits of choosing IRA distributions over your lifetime, the stretch IRA strategy, instead of taking a lump-sum distribution or emptying the account in a few years. As you can see, the younger you are when you inherit the funds, the greater the potential of the account.

3 The stretch IRA concept Total IRA distributions over beneficiary s lifetime Age expectancy Value of IRA when inherited by beneficiary $100,000 $500,000 $1,000,000 Total projected distributions years 1,740,307 8,701,264 17,402, years 1,045,316 5,226,414 10,452, years 640,394 3,201,872 6,403, years 407,695 2,038,414 4,076,824 Assumptions: RMDs only taken, 7% annual return. This chart is hypothetical and is provided for informational purposes only. It is not intended to represent any specific investment. When deciding whether to initiate a stretch IRA strategy, an investor should consider such factors as possible changes to tax laws, the impact of inflation, and other risks. Please note that designating a beneficiary two or more generations below the IRA owner may result in additional taxes when the distribution is made (exemptions may apply). Please consult with your tax advisor for more information. Multiple beneficiaries If you are one of multiple beneficiaries you will each be best served by setting up separate Inherited IRAs by December 31 of the year following the IRA owner s year of death. This allows each beneficiary to take advantage of the stretch IRA strategy by calculating RMDs based on his or her own single life expectancy (term-certain), manage investment decisions, and name successors for the Inherited IRA. If the deceased owner s account is NOT divided by December 31 of the year following the year of death, RMDs will be based on the age of the oldest beneficiary. In determining the oldest beneficiary for RMD purposes, beneficiaries who have received their portion of the retirement asset or who have properly and timely disclaimed by September 30 of the year following death are not considered. Roth IRAs Beneficiaries who inherit a Roth IRA that has been opened at least five years will receive all distributions income tax-free. So by just taking RMDs you can have potential earnings growing tax-free that could be used to help fund your own retirement. Converting to a Roth IRA Nonspouse beneficiaries can convert employer-sponsored retirement plan assets to an Inherited Roth IRA as a direct rollover, but cannot convert a Traditional IRA they inherit to an Inherited Roth IRA. Keep in mind that conversion triggers taxes due on any taxable amount and distributions will still need to be taken from an Inherited Roth IRA. For this reason, there may be no benefit on paying tax on the entire amount all at once. The Roth conversion decision is complex and you should seek advice from your tax professional. Naming a beneficiary on an Inherited IRA As a beneficiary, you ll want to designate your own successor beneficiary to your Inherited IRA. This allows your named successor to continue taking RMDs over your original life expectancy rather than taking a lump-sum distribution. The IRS does not let your successor start over and stretch inherited assets out over his or her own lifetime. Disclaiming an IRA One of the reasons you may want to disclaim the assets is to pass them on to a younger beneficiary. The younger the person is who inherits the asset the longer they have to stretch the IRA, potentially enhancing family wealth. For example, if you are a parent named as primary beneficiary who does not need the money and your children are named as the contingent beneficiaries, you might wish to disclaim in favor of their longer life expectancies. Key considerations There are a few things to consider when handling the deceased person s account and managing the funds. When moving inherited retirement assets, nonspouse beneficiaries do not have a 60-day rollover option. To preserve the tax-deferred status, IRA assets should be moved directly between IRA custodians or if a qualified plan, using the direct rollover process. The division of the deceased s account into separate Inherited IRAs is a plan-to-plan transfer and not a taxable event.

4 Nonspouse beneficiaries do not have the ability to roll over a retirement account they inherit to their own IRA. Any RMD that should have been taken by the deceased in the year of death must be distributed by the beneficiaries from the Inherited IRA by December 31 of the year of death. The beneficiaries are only responsible for their portion of the RMD based on the portion of the IRA they inherited. They will owe ordinary income tax on any taxable portion of the distribution. A Roth IRA owner is always considered to have died before their required beginning date, so they will have no RMD due in the year of death. Beneficiaries avoid the 10% penalty when taking a distribution from an Inherited IRA no matter their age as this is a death distribution. Calculating the RMD for Inherited IRAs:* Example 1 IRA owner dies in year 2013 Ed dies in year The beneficiary of his IRA is John, his son. Ed s IRA is moved into an Inherited IRA with John as beneficiary. On December 31, 2013, the IRA account value is $100,000. John s attained age in year 2014 will be 35. The Single Table shows a life expectancy of 48.5 years for a 35-year old. To satisfy his RMD for year 2014, John must distribute at least $2,062 from the Inherited IRA prior to December 31, 2014 ($100, = $2,062). Formula Value at last year s end Beneficiaries who chose the life expectancy option must take a yearly RMD by December 31 from the Inherited IRA beginning with the year following the year of death. When a trust is named as the beneficiary, assuming it meets certain IRS requirements to be considered a look-through, RMDs will be based on the age of the trust s oldest beneficiary. Single Table divisor for attained age in year following IRA owner s year of death 1 for each subsequent year Required Minimum Distribution (RMD) Calculating your Inherited IRA RMDs If you chose the life expectancy or stretch IRA strategy, keep in mind that this option requires the first RMD to be taken no later than December 31 of the year following the deceased year of death. The first year s divisor is obtained from the IRS Single Expectancy Table (see below). This divisor is reduced by one in each subsequent year for determining the RMD. Note: If the deceased is younger than you and dies after their RBD, their age in year of death can be used instead of yours for purposes of determining the single-life table divisor used. This divisor is reduced by one in each subsequent year. (See table below.) Example 2 IRA owner dies BEFORE year 2013 Maxine dies in year The beneficiary of her IRA is Judy, her sister. Maxine s IRA assets are moved into an Inherited IRA with Judy as beneficiary. Judy s attained age in year 2011 was 50. The Single Table shows a life expectancy of 34.2 for a 50-year old. In order to calculate the RMD for 2013, the life expectancy divisor for year 2011 must be reduced by 2 to reflect the subsequent years (2012 and 2013). Therefore, the life expectancy divisor for year 2013 is The IRA account value on December 31, 2012, is $250,000. To satisfy her RMD for 2013, Judy must distribute at least $7,764 ($250, ) prior to December 31, * These hypothetical examples are provided for informational purposes only. Our firm is not a tax or legal advisor. Be sure to consult with your own tax and legal advisors before taking any action that may have tax or legal consequences.

5 Single Expectancy Table** Age Expectancy Age Expectancy Age Expectancy Age Expectancy Age Expectancy Age Expectancy **Source: IRS Publication 590 Talk with us At our firm, we understand your desire to maximize the benefits of your inheritance. Please contact your financial professional for further information on how to handle your individual situation. Important dates a beneficiary should remember Nine months after the IRA holder s death Deadline for beneficiaries to disclaim assets 1 Only if Roth account has been opened for at least 5 years. 2 Stretch IRA strategies are designed for investors who will not need the money in the account for their own retirement. There is no guarantee that there will be assets remaining in the account at the time of the IRA owner s death. When deciding whether to initiate a stretch IRA strategy, an investor should consider such factors as possible changes to tax laws, the impact of inflation, and other risks. Please note that designating a beneficiary two or more generations below the IRA owner may result in additional taxes when the distribution is made (exemptions may apply). Please consult with your tax advisor for more information. INVESTMENTS AND INSURANCE PRODUCTS: NOT FDIC INSURED NOT BANK GUARANTEED MAY LOSE VALUE Please Note: This material has been prepared for informational purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. The accuracy and completeness of this information is not guaranteed and is subject to change. It is based on current tax information and legislation as of July, Since each investor s situation is unique you need to review your specific investment objectives, risk tolerance and liquidity needs with your financial professional(s) before a suitable investment strategy can be selected. Also, since our firm does not provide tax or legal advice, investors need to consult with their own tax and legal advisors before taking any action that may have tax or legal consequences. Accounts carried by First Clearing, LLC, Member NYSE/SIPC First Clearing, LLC ECG September 30 of the year following the IRA holder s death Deadline for beneficiaries to be determined December 31 of the year following the IRA holder s death Deadline for the following: First RMD, if life expectancy option is chosen Establishment of separate accounts for multiple beneficiaries in order to use their own life expectancy Direct rollover of qualified employer sponsored plan into Inherited IRA Five years December 31 deadline for entire IRA balance to be distributed if chosen and the owner died before the required beginning date.