Inherited IRA and Nontaxable contributions | Ed Slott and Company, LLC

Inherited IRA and Nontaxable contributions

When my grandmother died, she had a 403b plan and a qualified pension plan from her municipality (she worked in the public school system). My mom and my uncle were her only beneficiaries. My grandmother never actually retired from the school system - she passed away while on leave of absence.

My mom opened an inherited IRA at a brokerage firm to receive her portion of 403(b) distribution - this was easy since the entire amount was considered a taxable distribution and since my grandmother never actually retired and was still working for the same organization that sponsored her plan, she never actually hit her required begin date for RMDs (even though she was 88).

My question is around the pension plan distribution - as it turns out, some of the distribution is taxable (pre-tax contributions that my grandmother made, as well as the investment income earned from those contributions), but some is not - particularly the post-tax contributions that my grandmother made (the municipal system requires employees to contribute pre-tax and post-tax to the system for a number of years to "pay into" the pension; after that, you're fully vested and your contributions are used to grow the fund to fund your retirement benefit), as well as the term life insurance benefit that is paid when a member of the system passes away.

When all of the paperwork was submitted to the municipal system, it was unknown at that time that 2/3 of the distribution from the pension plan would be non-taxable; all of the paperwork seemed to indicate that most of it would be taxable. As such, the paperwork was completed to send the funds to the Inherited IRA at the brokerage firm.

If the municipal system sends one lump sum check for the whole amount to the brokerage firm for deposit into the already existing (and properly titled) Inherited IRA, can my mom withdraw the non-taxable funds (post-tax contributions + life insurance proceeds) without incurring additional tax? I understand she would still have to take an RMD based on the remaining taxable funds, but the basis would be significantly lower without the non-taxable funds in the account.

Any advice is appreciated.

  • Basis from either of these plans that is rolled into an inherited IRA should be documented on Form 8606. There should be a final statement from the pension plan to indicate the dollar amount of basis included in this rollover. The first year that an RMD or any additional distribution is taken out of the inherited IRA, an 8606 should be filed showing the amount of basis on line 2. The rest of Part I of the 8606 will then calculate the amount of basis "recovered" each year and that amount is non taxable to your Mom. Line 14 will then show the remaining basis which will be carried over to line 2 of the following year 8606 etc.
  • I assume that Mom's inherited IRA holds only balances inherited from grandmother.
  • Too late now, but your mother should have rolled over the pension plan with all that basis into an inherited ROTH IRA even though the 403b had already been rolled into a traditional inherited IRA. With the inherited Roth IRA with high basis the RMDs would be calculated in the same manner. For the year of the direct rollover, taxes would be rather high because the lower pre tax amount would be taxable then. But thereafter all RMDs would be non taxable and by the time earnings generated in the Roth were distributed, 5 years would have passed and they would also be non taxable. So no taxes due after that first year.

Thanks for your help!

Alan, would there have been an RMD from the 403(b) for the year of death at age 88? (Just now saw this posting.)

Benn, no because she passed prior to the RBD since she apparently had not "retired" from the school district and by definition a 403b participant cannot be a 5% owner.  Pretty unique for age 88.

Alan, thanks again for your information. Fortunately, the municipal system did NOT send the non-taxable funds to the inherited IRA (guess they knew what to do) and sent separate checks, so the whole 'basis' issue is a wash. As far as being 88 and still working - my grandmother was definitely a unique whippersnapper and enjoyed her work; interacting with teenagers kept her mind spry. Eventually though, it was her body that gave out.

 

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