To preserve the ability to stretch IRA distributions for a beneficiary, that individual must start taking withdrawals based on his/her life expectancy in the year after death. If those required withdrawals don't start on time, can you still rectify the situation to preserve the tax deferral?
The good news is that recent private letter ruling 200811028 (and more recently, IRS Information Letter 2016-0071) indicates the answer is "yes."
PLR 200811028 And IRS Information Letter 2016-0071 On Taking RMDs From A Stretch IRA After The Fact
In the recently released Private Letter Ruling 200811028, an IRA owner died in 2002 and the beneficiary failed to take any distributions from the account until 2005. In 2005, the beneficiary took all of the make-up distributions from the RMDs that were not taken in 2003 and 2004 (in addition to taking the 2005 amount), and paid the 50% excise penalty for the insufficient RMDs for 2003 and 2004, but in return the IRS allowed the beneficiary to subsequently continue RMDs based on the beneficiary's life expectancy, preserving a significant amount of tax deferral for the bulk of the IRA.
Normally, to preserve the ability to stretch over the beneficiary's life expectancy, distributions should have commenced by December 31, 2003, as required by Treas. Reg. 1.401(a)(9)-3, Q&A-3 and IRC Section 401(a)(9)(B)(iii). However, the Service acknowledges that the "default" rule for post-death distributions is to apply the life expectancy rule (as supported in Treas. Reg. 1.401(a)(9)-3, Q&A-4); thus, in essence the Service's view was not that the beneficiary had made an election to take distributions out more rapidly (e.g., under the 5-year rule since the decedent died prior to his/her required beginning date), but simply that the beneficiary had failed to take withdrawals according to the default rule. Thus, the beneficiary could come back into conformance with the life expectancy stretch rules by simply making up the missed RMDs, paying the associated 50% penalty, and then proceeding forward with the non-spouse stretch IRA from that point on.
Although this PLR is only that - a private letter ruling, and not necessarily binding on the IRS - the logic in the ruling is fairly straightforward, and some IRA experts have suggested for many years that this should be an available (albeit untested) remedy. Whether it is appealing in any particular situation, though, will still depend on the facts and circumstances of the situation. The cost for fixing a botched RMD situation is not cheap - aside from the potential concentrated income (and thus higher marginal tax rates) on several years of RMDs lumped into a single year, the beneficiary must still pay the whopping 50% excise tax on the amounts that were not appropriately withdrawn. If it's only one year's worth of RMDs, and the beneficiary is young and may stretch the IRA for 4-6+ decades, this is probably still a very good deal. On the other hand, if there are more years of failed RMDs and associated penalties, or if there's a high risk the beneficiary will withdraw the funds more rapidly anyway, and/or if the beneficiary is older and doesn't have as long of a life expectancy, this remedy may not be as appealing. And of course, because this is only guidance via a PLR, some beneficiaries may ultimately wish (or find it necessary as a mandate from the IRA custodian) to get their own ruling to secure their particular situation (which has its own associated cost).
Nonetheless, the fact that the strategy has now worked at least once in a direct ruling from the IRS is promising, and provides a better roadmap for how other beneficiaries that have botched IRA RMDs or a failed stretch may be able to remedy their own situation in the future!
(Michael's Note: Since this article was originally published, the IRS issued Information Letter 2016-0071, which further affirms that missing the first post-death RMD does not eliminate the ability to stretch the IRA. Though the missed RMD must still be made up, and the potential 50%-for-failing-to-take-an-RMD penalty will apply, unless waived under Form 5329.)
It is such a great article. Had fun reading it. For those who are new to the idea of IRA it is an investing tool used by individuals to earn and earmark funds for retirement savings. There are several types of IRAs: Traditional IRAs, Roth IRAs, SIMPLE IRAs and SEP IRAs. You can find out more about IRA at http://www.rollover-ira.info which was of great help when I was looking for a retirement arrangement.
Scott Waidelich says
Comment, My mom has an Annuity IRA with American Equity Investment,. She passed away 12/29/2016 and we missed selecting the Inherited Stretch option within 1 year of her passing. We had some personal circumstances and we missed it by 4-5 weeks. We also didn’t take a 2017 minimum distribution. Are you aware of any IRS PLR’s where they would allow us to select the inherited stretch option if we pay the 50% penalty on the 2017 MDR? We would like to avoid taking the lump sum and losing the IRA status of the money. Scott
Michael Kitces says
IRS Information Letter 2016-0071 (see https://www.irs.gov/pub/irs-wd/16-0071.pdf) has affirmed that the “default” is the stretch rule, unless you proactively make an election to take under the 5-year rule. Which means missing the first RMD is not fatal to taking a stretch.
However, at this point making up for the stretch would require taking the 2017 RMD that was missed, and paying the 50% failure-to-take-RMD penalty for the amount that wasn’t taken (or apply for a Waiver via Form 5329) before you proceed on track for the original stretch.
This is available as long as the annuity contract itself doesn’t REQUIRE something more restrictive (as the IRA rules just define what CAN be done, but a more restrictive annuity contract REQUIRES you to follow the terms of the contract). As long as the annuity contract allows the flexibility to stretch, though, the IRS would as well. (But you’ll have to navigate the missed RMD and potential missed-RMD-penalty.)