Inherited IRA Information Sheet Inheriting an IRA, whether it s a Traditional or Roth, raises a lot of questions. If you are reading this information sheet, the likelihood is that you are either the beneficiary of a deceased IRA Owner and you are thinking about taking your benefits, or you are an IRA Owner who wants to know what distribution options will be available to your beneficiaries. There are a number of terms that you may not be familiar with as used in this context. They are generally defined here. Designated Beneficiary: For purposes of the Required Minimum Distribution ( RMD ) rules (refer to below definition), in general, a designated beneficiary is an individual designated as a beneficiary under the deceased Owner s original IRA, who remains a beneficiary as of September 30 of the year following the year of the IRA Owner s death. As well as determining who actually receives distributions from the deceased Owner s IRA, the identity of the beneficiaries will affect the life expectancy that will be used to calculate Required Minimum Distributions. If the IRA has multiple beneficiaries that are all individuals, unless each has established a separate account (as described below) by December 31 of the year following the year of the IRA Owner s death, the oldest individual will be the designated beneficiary. If the IRA beneficiary is a nonliving entity, for example, the estate or a charity, or a trust, there will generally not be a designated beneficiary. Special rules apply to trusts. If certain requirements are met, a trust that is the IRA s beneficiary may be looked through, so that one of the trust s individual beneficiaries might qualify to be a designated beneficiary. (Generally, this would be the beneficiary with the shortest life expectancy.) Separate account rules are generally not available to beneficiaries of a trust with respect to the trust s interest in the IRA. Five-Year Rule: This beneficiary option requires you to withdraw all of the IRA assets either in a lump sum or in installments by December 31st of the fifth full year following the year of death of the IRA Owner. If this rule applies, no distribution is required for any year before that fifth year. For example, if an IRA Owner dies in 2007, the beneficiary would have to withdraw all of the assets by December 31, 2012. Instead, the beneficiary may be able to choose to take payments based on his or her life expectancy as explained below, but those payments must begin by the end of the year following the year of the IRA Owner s death. Inherited IRA: An IRA that holds only assets of an IRA of a deceased original Owner, for the benefit of the beneficiary or beneficiaries. You cannot make regular contributions to an Inherited IRA. Life Expectancy Payments: This beneficiary option requires you to take payments annually based on a life expectancy. When you take these payments because of the death of the IRA Owner, they are based on a single life expectancy and are referred to as Required Minimum Distributions ( RMDs ). You can always take a payment that is larger than your RMD. To choose this option, you must commence payments no later than the end of the year following the year of the IRA Owner s death. Life expectancy payments are made on the life expectancy of the designated beneficiary or, in certain cases, based on the life expectancy of the decedent. Options: In this instance, options means the different ways (Five-Year Rule, Life Expectancy Payments) you can choose to take the proceeds. Remainder Beneficiary: The beneficiary of an IRA may designate an individual, trust, estate or other entity to receive distributions of any balance remaining in the IRA after the beneficiary s death. Required Beginning Date ( RBD ): April 1st of the year following the year in which the IRA Owner reaches or in some cases would have reached age 70 1 2. Required Minimum Distribution: The minimum amount that the IRS requires the Owner of a Traditional, SIMPLE, SEP or SAR-SEP IRA to take each year starting the year the IRA Owner turns 70 1 2. Failure to take a RMD when due may subject the IRA Owner to an excise tax penalty of 50% of the amount that should have been taken.
RMDs also apply to the beneficiary of the IRA Owner, including the beneficiary of a Roth IRA, and can require an earlier commencement. The beneficiary of an IRA is required to take postdeath RMDs from an IRA when the IRA Owner dies. Failure to take a postdeath RMD may subject the beneficiary to an excise penalty tax of 50% of the amount that should have been distributed. Many beneficiaries have the following important questions: I m the beneficiary on an IRA. How can I take the proceeds? The distribution options that are available to you are outlined in the following pages. We urge you to consult your personal tax or legal advisor to be sure that you understand your choices thoroughly before you make your decision. This information sheet does not address all of the rules that may apply to your specific situation, and it is intended to be a general overview based on our interpretation of the rules. Morgan Stanley Smith Barney and its Financial Advisors do not provide tax or legal advice. The tax laws concerning RMDs are particularly complex and subject to change. What kind of documentation will I need to claim my benefits? You will need an original certified death certificate. Your Financial Advisor will let you know what additional paperwork is required in order to claim your benefits. What happens to the IRA account of a deceased Owner? If you are the spouse of a deceased IRA Owner and have been named as the sole beneficiary of the IRA (including if the IRA has multiple beneficiaries, but is split into separate IRAs by the last day of the year following the year of the original IRA Owner s death, and you as surviving spouse are sole beneficiary of one of those separate Inherited IRAs), you may elect to treat the IRA as your own, as discussed below. If you are the surviving spouse of the original Owner but not the sole beneficiary, and you receive a distribution, you may decide to roll the proceeds into your own existing or new IRA. If you do this, the old account will be closed. In other cases, the IRA will become the Inherited IRA of the beneficiary. For an Inherited IRA, the name on the account will still include the original IRA Owner s name as well as the name of the beneficiary; for example, John Doe (DECD) FBO Mary Doe (BENE). The beneficiary must take applicable RMDs from this account. Distributions will be reported on the IRS Form 1099-R, under the beneficiary s Social Security Number, and may be subject to ordinary income tax. What if I am one of a number of beneficiaries of an IRA? For purposes of calculating RMDs, it matters whether there is one beneficiary or multiple beneficiaries. However, even if there are multiple beneficiaries, if a decedent s IRA is divided into separate accounts for the separate beneficiaries by December 31st of the year following the year of the decedent s death, each such beneficiary IRA should be treated as a separate account for these purposes for which the RMD rules can be applied. Treasury regulations generally applicable to qualified retirement plans provide that a separate account must reflect the separate interests of the decedent s beneficiaries as of the date of the IRA Owner s death, maintain separate accounting, and allocate all post-death gains and losses, as well as distributions. Separate accounting may provide for separate investments in each account with gains and losses attributable to such investments allocable only to that account. While there is some uncertainty as to how to apply this requirement to IRAs (and not qualified plans), and different vendors (as well as different tax and legal practitioners) take different positions as to whether an IRA with subaccounts (that is, a single IRA with separate subaccounts, all coded as part of a single IRA account) can satisfy this requirement, as a practical matter, due to the administrative difficulty of performing such accounting in a single Inherited IRA, we believe that separate accounts are usually created for this purpose by establishing separate Inherited IRAs for each beneficiary and transferring the assets for each beneficiary to his or her Inherited IRA. Are there deadlines that I need to be aware of in taking the proceeds? Yes, there are deadlines that depend upon the facts and the applicable option. You must comply with them to avoid excise taxes. How will the benefits be taxed? Depending on whether the IRA is a Traditional or Roth, the proceeds you receive may be taxable as ordinary income or be distributed tax-free. (Special rules apply to determine the taxation of nontaxable contributions distributed from Traditional IRAs and qualified and nonqualified distributions from Roth IRAs.) Please consult your tax advisor for more information. That may influence your decision as to how quickly you take the proceeds. You should consult your tax and legal advisors before you make your choice. You should also keep in mind that the IRA may be includable in the estate of the decedent and that payments from the IRA may be income in respect of a decedent (IRD). The tax rules for estates and IRD are also very complex and you should consult with your tax advisor as to how they will apply to you. Can I designate a beneficiary for my Inherited IRA? Generally, the beneficiary of the original Owner can name one or more remainder beneficiaries who could continue to receive the annual RMDs, established by the original Owner or beneficiary, until the end of the original payout term. The remainder beneficiary cannot increase the number of years over which the IRA could be paid. Instead, annual RMDs are only redirected to the remainder beneficiary(s). 2
Can I move the assets in the IRA that I inherited from my mother to a Morgan Stanley Smith Barney Inherited IRA? The IRS allows beneficiaries to directly transfer inherited IRA assets from one financial organization to another. The transfer, in itself, is not a taxable event. The Inherited IRA must be set up and maintained at Morgan Stanley Smith Barney as an Inherited IRA and the Required Minimum Distributions rules apply. I am the beneficiary of my brother s qualified retirement plan. Can I roll over the proceeds into an IRA with Morgan Stanley Smith Barney? If a participant in a retirement plan (such as a 401(a), 401(k), 403(b) or governmental 457(b) plan) dies leaving his or her accrued benefit to a nonspouse beneficiary, the plan may permit the beneficiary to roll over the inherited funds into an IRA set up to receive the funds. In order to do so, the rollover must be accomplished by a direct rollover (that is, a transfer directly from the retirement plan to the Inherited IRA). While checks can be accepted from the plan trustee, it is very important that beneficiaries not take qualified plan distribution checks made payable to themselves alone. They can only take checks that are made out to the properly titled Inherited IRA. Beneficiaries cannot deposit these funds into an IRA in their name alone or in other IRAs with Morgan Stanley Smith Barney. For purposes of minimum distributions and in all other regards, the IRA will be treated as an Inherited IRA. See below for special rules on how the way you take distributions from the retirement plan may affect how you must calculate the RMDs from the transferee Inherited IRA. Special Timing Rules for Taking RMDs from an Inherited IRA after a Nonspouse Beneficiary Direct Rollover How a nonspouse beneficiary has been receiving distributions from a retirement plan can affect the RMD rules applicable to the Inherited IRA if the nonspouse designated beneficiary makes a direct transfer from the retirement plan to the Inherited IRA. In the case of a nonspouse beneficiary rollover to an Inherited IRA, the rules for determining the RMDs under the transferor plan with respect to the nonspouse beneficiary also apply under the IRA. Thus, if the Participant died before his or her RBD and the Five-Year Rule applied to the nonspouse beneficiary under the plan making the direct rollover, the Five-Year Rule applies for purposes of determining RMDs under the Inherited IRA. If the life expectancy rule applied to the nonspouse beneficiary under the transferor plan, the RMD under the Inherited IRA must be determined using the same applicable distribution period as would have been used under the plan if the direct rollover had not occurred. Similarly, if the retirement plan participant died on or after his or her Required Beginning Date, the RMD under the Inherited IRA for any year after the year of death must be determined using the same applicable distribution period as would have been used under the transferor retirement plan if the direct rollover had not occurred. Factors That Affect Your Options There are a number of different factors that affect your distribution options. The calculation of RMDs after the death of the IRA Owner depends on the type of beneficiary that was designated (for example, spouse as sole beneficiary, nonspouse, or nonliving entity), because different rules apply for each type of beneficiary. In certain situations, the calculation of RMDs also depends on when the IRA Owner died, whether before or after his/her Required Beginning Date or whether before or after commencing to receive benefits. Another important factor is the type of IRA, whether it is a Traditional (including SEP, SAR-SEP), SIMPLE, or Roth IRA. A spouse beneficiary has different options than a nonspouse beneficiary. A surviving spouse who is the sole designated beneficiary of the IRA generally may elect to treat the decedent s IRA as his or her own IRA, rather than open an Inherited IRA. Accordingly, that spouse is then treated as an Owner, not as a beneficiary, and would not open up an Inherited IRA. If you are the sole designated beneficiary and have an unlimited right of withdrawal, you may elect to treat the IRA as your own by changing the name on the account to your name. You are automatically deemed to have made this election if you either: i. Make a contribution to the account or ii. Fail to start taking RMDs by the later of December 31st of the year after the IRA Owner s death or the year the IRA Owner would have attained age 70 1 2. When you are a spouse designated as sole beneficiary, your age may influence your decision, too. For instance, if you are under 59 1 2, you may consider keeping the IRA in the decedent s name as an Inherited IRA rather than rolling the proceeds into your own new or existing IRA or treating it as your own IRA. This is of particular importance if you will need distributions before age 59 1 2. By keeping the assets in an Inherited IRA as a beneficiary, any distribution may be subject to income tax but not the 10% penalty. If you treated the IRA as your own IRA and then needed a distribution before age 59 1 2, the 10% additional tax would be imposed, unless another exception to the 10% penalty applies under 3
the Internal Revenue Code. Alternatively, if you are the surviving spouse and sole designated beneficiary and are substantially older than the IRA Owner, you may wish to leave the IRA in your deceased spouse s name and wait to make a choice until the end of the year in which the decedent would have turned age 70 1 2. If an IRA of a deceased Owner has multiple beneficiaries and only one of them is the Owner s surviving spouse, the IRA may be split into separate accounts or separate IRAs by the last day of the year following the year of the original Owner s death. In that event, each separate account or IRA will be treated as a separate IRA, and the surviving spouse can be treated as the sole beneficiary of the IRA split off for that surviving spouse. Distribution Options from a Traditional, SEP, SAR-SEP or SIMPLE IRA With a Traditional, SEP, SAR-SEP or SIMPLE IRA, your distribution options depend on whether or not you are the spouse of the IRA Owner (and if you are the spouse, whether you are the sole beneficiary) and whether the IRA Owner died before or after his Required Beginning Date ( RBD ). Remember, the RBD is generally the April 1st of the year following the year in which the IRA Owner reaches or would have reached age 70 1 2. The IRS requires that Owners of Traditional, SEP, SAR-SEP or SIMPLE IRAs take minimum distributions from those accounts in the year that they become 70 1 2 and in subsequent years. You, as the beneficiary of an IRA, are subject to the Required Minimum Distributions ( RMD ) rules when the IRA Owner passes away. If you do not take the RMD on time, as explained below, you may be subject to an excise penalty tax of 50% of the amount that should have been distributed. When the IRA Owner Dies Before His or Her Required Beginning Date When you are a spouse beneficiary and the IRA Owner dies before his or her RBD, and you do not elect to treat it as your own IRA, you have these options: Five-Year Rule You can withdraw all of the assets either in a lump sum or in installments by the end of the fifth calendar year following the year of death of the IRA Owner. Life Expectancy If you, the spouse, are the sole designated beneficiary, you also may distribute based on your single life expectancy, on a recalculated basis. The distributions must begin by the end of the year (December 31st) following the year in which the IRA Owner died, or the year the IRA Owner would have been 70 1 2 years old, whichever is later. The life expectancy factor used to calculate your RMD is based on your age on your birthday in each year for which a distribution must be made. If you, as the spouse beneficiary, pass away after distributions start but before the IRA is exhausted, distributions may continue to your remainder beneficiary based on your remaining life expectancy, but determined on a nonrecalculated (term-certain) basis. When you are an individual nonspouse beneficiary and the IRA Owner died before his or her RBD, these are your options: Five-Year Rule You can withdraw all of the assets either in a lump sum or in installments by December 31st of the fifth calendar year following the year of death of the IRA Owner. Life Expectancy Distribute based on your single life expectancy using the nonrecalculation (term-certain) method. The distributions must begin by the end of the year (December 31st) following the year of death of the IRA Owner. The life expectancy factor should be determined using your age in the year after the year of the IRA Owner s death. When the nonspouse designated beneficiary is comprised of multiple individuals (and assuming the IRA has not been divided into separate IRA accounts by December 31 of the year following the year of the IRA Owner s death see above on page 2), these are the options: Five-Year Rule Withdraw all assets either in a lump sum or in installments by December 31st of the fifth calendar year following the year of death of the IRA Owner. Life Expectancy Distribute based on the single life expectancy of the oldest designated beneficiary, using the nonrecalculation (term-certain) method. The life expectancy factor is determined using the oldest designated beneficiary s age in the year after the year of the IRA Owner s death. Distributions must begin by the end of the year (December 31st) following the year of death of the IRA Owner. This rule applies even if one of the multiple beneficiaries listed is the IRA Owner s surviving spouse. If the nonspouse beneficiary is a nonliving entity (such as a charity or the estate) or multiple beneficiaries including at least one nonliving entity (and assuming the IRA has not been split into separate IRAs by the last day of the year following the year of the original Owner s death as described above), there is only one option: Five-Year Rule Withdraw all assets either in a lump sum or in installments by December 31st of the fifth calendar year following the year of death of the IRA Owner. 4
When the IRA Owner Dies After the Required Beginning Date When you are a spouse beneficiary and the sole designated beneficiary and the IRA Owner dies after the required beginning date, and you do not elect to treat it as your own IRA, you have this option: Life Expectancy of you or of deceased IRA Owner Distribute based on the longer of your single life expectancy, recalculated or the remaining life expectancy of the IRA Owner as determined as of the birthday of the IRA Owner in the calendar year of the IRA Owner s death, using the nonrecalculation (term certain) method. You may also distribute more rapidly. If you die on or after December 31st of the year after the year of the IRA Owner s death, distributions may continue based on your remaining life expectancy, determined on a nonrecalculation (term-certain) basis. When you are an individual nonspouse designated beneficiary and the IRA Owner dies after the required beginning date, this is the option: Life Expectancy(of Owner) Distribute based on the longer of the remaining life expectancy of the IRA Owner determined as of the birthday of the IRA Owner in the calendar year of the IRA Owner s death or your single life expectancy using the nonrecalculation (term-certain) method. The distributions must begin by December 31st following the year of death of the IRA Owner. The life expectancy factor for the first RMD is based on your age as of your birthday in the year after the year of the IRA Owner s death. You may also distribute more rapidly. When the nonspouse designated beneficiary is comprised of multiple individuals (assuming the IRA account has not been divided into separate IRA accounts by December 31 of the year following the year of the IRA Owner s death), this is the option: Life Expectancy(of Owner) Distribute based on the longer of the remaining life expectancy of the deceased IRA Owner determined as of the birthday of the deceased IRA Owner in the calendar year of the IRA Owner s death or single life expectancy of the oldest designated beneficiary, using the nonrecalculation (term-certain) method. The life expectancy factor starts with the oldest designated beneficiary s age in the year after the year of the IRA Owner s death. Distributions must begin by the end of the year following the year of death of the IRA Owner. This rule applies even if one of the beneficiaries is the IRA Owner s spouse. You may also distribute more rapidly. If the nonspouse beneficiary is a nonliving entity (such as a charity or the estate) or there are multiple beneficiaries including at least one nonliving entity (and assuming the IRA account has not been divided into separate accounts by December 31 of the year following the year of the IRA Owner s death), there is only one option: Life Expectancy(of Owner) Distribute based on the deceased IRA Owner s remaining single life expectancy, nonrecalculating (term-certain), based on the IRA Owner s age on his or her birthday in the year of death. This rule applies even if one of the beneficiaries listed is the IRA Owner s spouse. Distributions from a Roth IRA Although a Roth IRA Owner is not subject to Required Minimum Distribution ( RMD ) rules at age 70 1 2, the beneficiary of a Roth IRA is subject to RMD rules when the Roth IRA Owner dies. Therefore, if you are a beneficiary of a Roth IRA and you neglect to take a RMD on time, you may be subject to an excise penalty tax of 50% of the amount that should have been distributed. The RMD rules that apply to the beneficiary of a Roth IRA are the same as those that apply to determine required minimum distributions where an IRA Owner dies before his or her required beginning date. How to Determine the Required Minimum Distributions If you choose to take distributions over your life expectancy, and Morgan Stanley Smith Barney has all of the required information, we will estimate your Required Minimum Distributions for you. If you wish to calculate it yourself, the amount of the Required Minimum Distribution is generally determined by taking the IRA account balance as of the end of the prior year (December 31st value), then dividing it by the applicable life expectancy factor obtained from the Single Life Expectancy Table. This amount is only a minimum; you may take more than this amount. The Required Minimum Distribution formula is: December 31 prior-year balance/ Life Expectancy Factor=Required Minimum Distribution 5
How to Determine the Life Expectancy Factor Single, Recalculated Life Expectancy: If you are a spouse beneficiary and you choose this option, your life expectancy factor is determined annually using your age as of your birthday in each year for which the Required Minimum Distributions must be made and you are alive. You will refer back to the Single Life Expectancy Table (page 7) each calendar year to obtain the new factor. Single, Nonrecalculated (Term-Certain) Method: If you are a nonspouse designated beneficiary, your life expectancy is calculated using your age in the year following the year of the IRA Owner s death, using the Single Life Expectancy Table (page 7). The life expectancy factor is reduced by one for each subsequent year. You do not refer back to the Single Life Expectancy table annually. This method is also used by remainder beneficiaries. In the case of a nonspouse beneficiary taking RMDs based on the remaining life expectancy of the deceased IRA Owner, the life expectancy of the deceased IRA Owner is determined as of the birthday of the deceased IRA Owner in the calendar year of the IRA Owner s death. When the Beneficiaries of an IRA Account are Determined For the purposes of calculating Required Minimum Distributions ( RMDs ), the designated beneficiary may be determined as late as September 30th following the year of the IRA Owner s death. The beneficiary may be changed after the IRA Owner s death only by one or more beneficiaries either disclaiming their interests in the IRA, or taking total distributions of their shares of the IRA. For example, an IRA Owner named his spouse as his sole primary beneficiary and his three children as his contingent beneficiaries. When the IRA Owner passed away on April 8th, 2007, his spouse decided to disclaim her right to the IRA assets. If the primary beneficiary disclaims the inheritance, this makes the contingent beneficiaries the new primary beneficiaries. One of the sons will fully distribute his allocation on September 1st, 2008. By September 30th, 2008, the remaining two sons would be considered the designated beneficiaries of their father s IRA. If there are multiple beneficiaries, the IRA may be split into separate accounts by December 31st of the year after the year of the IRA Owner s death. In that case, the distribution of each account will be calculated separately for each beneficiary. To continue with the example, if the two sons divide the IRA into separate accounts by the December 31st deadline, each son will be able to use his own life expectancy to calculate the RMDs to be distributed from the IRA. Trusts as IRA Beneficiaries A trust is generally a nonliving entity for purposes of the RMD rules. However, Treasury Regulations permit certain trusts to be treated as though the beneficiary of the trust is the designated beneficiary of the IRA. The rules that must be met by such trusts are complex and depend upon the terms of the trust and documentation that must be provided to the IRA custodian. You should consult your tax advisor as to whether they may apply to any trust designated as an IRA beneficiary. Trusts as beneficiaries are generally outside the scope of this information sheet, but see the discussion of Designated Beneficiary on page 1 herein. 6
Single Life Expectancy Table (For Use by Beneficiaries) Age Life Expectancy Age Life Expectancy Age Life Expectancy Age Life Expectancy 0 82.4 28 55.3 56 28.7 84 8.1 1 81.6 29 54.3 57 27.9 85 7.6 2 80.6 30 53.3 58 27.0 86 7.1 3 79.7 31 52.4 59 26.1 87 6.7 4 78.7 32 51.4 60 25.2 88 6.3 5 77.7 33 50.4 61 24.4 89 5.9 6 76.7 34 49.4 62 23.5 90 5.5 7 75.8 35 48.5 63 22.7 91 5.2 8 74.8 36 47.5 64 21.8 92 4.9 9 73.8 37 46.5 65 21.0 93 4.6 10 72.8 38 45.6 66 20.2 94 4.3 11 71.8 39 44.6 67 19.4 95 4.1 12 70.8 40 43.6 68 18.6 96 3.8 13 69.9 41 42.7 69 17.8 97 3.6 14 68.9 42 41.7 70 17.0 98 3.4 15 67.9 43 40.7 71 16.3 99 3.1 16 66.9 44 39.8 72 15.5 100 2.9 17 66.0 45 38.8 73 14.8 101 2.7 18 65.0 46 37.9 74 14.1 102 2.5 19 64.0 47 37.0 75 13.4 103 2.3 20 63.0 48 36.0 76 12.7 104 2.1 21 62.1 49 35.1 77 12.1 105 1.9 22 61.1 50 34.2 78 11.4 106 1.7 23 60.1 51 33.3 79 10.8 107 1.5 24 59.1 52 32.3 80 10.2 108 1.4 25 58.2 53 31.4 81 9.7 109 1.2 26 57.2 54 30.5 82 9.1 110 1.1 27 56.2 55 29.6 83 8.6 111 and over 1.0 Source: IRS Publication 590 7
Tax laws are complex and subject to change. Morgan Stanley Smith Barney LLC, its affiliates and Morgan Stanley Smith Barney Financial Advisors do not provide tax or legal advice, are not fiduciaries (under ERISA, the Internal Revenue Code or otherwise) with respect to the services or activities described herein, except as otherwise agreed to in writing by Morgan Stanley Smith Barney. This material was not intended or written to be used for the purpose of avoiding tax penalties that may be imposed on the taxpayer. Individuals are urged to consult their tax or legal advisors before establishing a retirement plan and to understand the tax, ERISA and related consequences of any investments made under such plan. 2010 Morgan Stanley Smith Barney LLC. Member SIPC. 08/2008 GP08-02730P-N08/08 PS24071 NY CS 5665538 PSC05/10