Not all IRA custodians are so cooperative, even if coaxed by a beneficiary or an advisor. Peggy Ruhlin, an advisor with Budros & Ruhlin Inc., Columbus, Ohio, tells of one bank that failed to meet the one-year test because it was "too busy," and thus blew the stretchout. "It was a relatively small IRA, about $80,000, but the client certainly didn't intend to pay the income tax as soon as will be required."
The "one-year test" refers to IRAs and other tax-deferred retirement accounts that are inherited by a nonspouse before the account owner starts taking required minimum distributions. Ordinarily, such accounts must be distributed by the end of the fifth calendar year following the account owner's death. However, distributions over the beneficiary's life expectancy are permitted if those distributions begin in the calendar year after death.
''Financial advisors must be aware of crucial deadlines, and they need to be persistent when dealing with balky custodians," says Kathy Stepp, an advisor with Stepp & Rothwell in Overland Park, Kan. "One of my clients lost both parents within a year. Two children have been named as beneficiary of a $1.2 million IRA, in addition to other assets. The custodian of the IRA is the same local bank that also is acting as estate executor and trustee."
This bank, according to Stepp, moves slowly on everything, including the IRA stretchout. "We'd like to get the IRAs separated and moved to Schwab, where we have most of our accounts," she says. "At the same time, we want to get the distributions started before Dec. 31 of the year following death, to qualify for a stretchout over the children's life expectancy. Bank officials, though, have dragged their feet on everything. They don't return calls, and they don't do what they said they would do."
Part of the problem, Stepp says, is that the bank does not want to lose this large IRA. "In addition, there has been some turnover among the bank personnel. When someone new comes in, we have to start all over, explaining what we'd like to do."
Missing the next-year deadline is not the only problem that may arise when a nonspouse inherits an IRA before the required beginning date. To qualify for the stretchout, the account should be kept in the decedent's name, perhaps in a special "for the benefit of" account, but changing the account's name to that of the beneficiary results in a taxable distribution.
"In one case," says Brodeski, "the IRA custodian changed the name of the decedent's IRA to the beneficiary's name. We were able to get the account changed back to the decedent's name, but now the custodian is throwing up roadblocks to prevent us from moving the account, as we'd like to."
Ken Greenblatt, an advisor with Time Capital Investor Advisory Services in Melville, N.Y., relates a similar story. "An IRA stretchout was arranged and agreed upon so the client - the beneficiary - was feeling comfortable," he says. "However, when the IRA owner died, the custodian changed the name, retitling the account in the name of the beneficiary. Fortunately, we were able to catch it and have it changed back before a 1099-R was sent out, reporting the income to the IRS. Once that's done, it's too late: There's no 'oops' clause in the tax code."
Greenblatt has another client with $1.5 million in a tax-deferred 403(b) retirement plan and no other assets. This plan gives nonspouse beneficiaries only two choices, he says. "They can take an annuity or take the amount in a lump sum. Practically speaking, I doubt that a beneficiary would want to take this amount in a lump sum and pay more than $600,000 in income tax."
The most likely choice, Greenblatt says, is to take an annuity. "In that case, the beneficiary gives up access to the principal. There might be $300,000 worth of estate tax due, but no money to pay it with."