Dear Gail-
My mother inherited my dad’s IRA when he died last fall. She was the only beneficiary and would like to roll it over into her name. He was 70½ when he died. My older brother says that my mom first needs to take the required distribution dad was supposed to take and then do the rollover. Is this correct?

Thanks,
Cindy

Dear Cindy-

Older brothers are not always right! (Although I suppose we can go easy on him in this case because the IRA rules are so complex.)

An IRA owner must begin “required minimum distributions” (RMDs) once he reaches age 70½. Since your dad had already reached this milestone last fall, I’m guessing that he celebrated his 70th birthday in June 2007 or earlier that year.

However, while your brother is correct in his reasoning, he is off in his timing.

Generally, your annual RMD must be taken by December 31 of each year. However, for your first year, you get a few extra months to accomplish this. IRA expert Ed Slott, a CPA in Rockville Centre, N.Y., points out that the deadline for your first RMD is April 1 of the year after you turn 70½. This is called your “required beginning date.”

Thus, your dad had until April 1, 2008 to start his annual required distributions.(1) Since he died before reaching this deadline, he technically had not started his RMDs. As a result, there is no need for your mom to take “his” first withdrawal before doing a rollover.

However, Slott points out that once the IRA is re-titled with your mom as the owner, if she is over age 70½, “then she has an RMD for 2008.” This would be based on her own life expectancy.

“But if she’s in her sixties,” says Slott, “She rolls it over and waits until she turns 70½” to begin RMDs.

Hope this clears things up,
Gail

1. Be careful! If you wait until the year after you turn 70½ to begin your required minimum distributions, you must take TWO withdrawals that year: one for the year you turned 70½ and the other for the year you turned 71.

Dear Gail-

I want to change the way my IRA is invested. Right now it’s in mutual funds. I’d like to sell them and invest the proceeds in an annuity, which my IRA would own.

The problem is, I’m 58 years old. When I got laid off a year ago and needed money, I started taking regular withdrawals from my IRA in the amount of 33,280/year. (My financial advisor set this up for me.)

I’m working again and, frankly, don’t need the money. However, I know I can’t stop these &!@# withdrawals. But I want some of the things you can get with an annuity, like a death benefit and a guaranteed return. That’s why I want to make the switch.

My adviser thinks I’ll get in trouble if I do this. What do you say?

Thanks,
George

Dear George,

I have one word for you: STOP!

Since you are under age 59½ you cannot withdraw money from a traditional IRA without getting hit by a 10% penalty unless you qualify for one of the exceptions. Apparently, the only way you could access your IRA assets was through the exception known as “substantially equal periodic payments.”

In layman’s language, this means you must withdraw essentially the same amount each year, which you’ve been doing. However, the other part of this exception is the timeframe: these withdrawals must be taken for 5 years or until you reach age 59½- whichever takes longer.

Although you’ll be 59½ either next year or in 2010 (depending upon whether your birthday falls in the first or second half of the year), you must still continue your annual withdrawals because you will not have hit the 5-year mark.

So, if you want to avoid the 10% penalty, you cannot stop withdrawing $33,280/year from your IRA until 2012. (By then you will have taken withdrawals for 5 years.)

What’s the worst that can happen if you do? The IRS will consider this a disruption or, “modification,” of your withdrawals and slap a 10% penalty on all of the money you’ve taken so far: $6,656 (10% x $66,650).

Notice that you will not: go to jail, have a lien slapped on your home, or lose your first-born child. In other words, yes, this is a big chunk of change. The penalty is severe because the government wants to make people think twice before they raid their retirement funds to pay for current living expenses.

And, there is no way you can “repay” the withdrawals; that money has forever lost the ability to appreciate inside an IRA account. Decades of tax-sheltered compounding are lost.

The question is: Do you want to see another $100,000 leave your IRA? (2)

If the answer is “no,” then the price for this is $6,656. To put this into perspective, consider that $100,000 would grow to nearly $450,000 (tax-deferred) if it earned 8%/year for 20 years.

Your concern about switching from mutual funds to an annuity inside your IRA is another issue. According to Slott, “If you change the investment, you still have to take the same amount out.” It’s doubtful a withdrawal of exactly $33,280 would be allowed under the terms of the annuity you’re considering.

If you change the annual amount you’re withdrawing, this will be considered a “modification” (see above) and you’ll trigger the retroactive 10% penalty. Slott, who’s authored a number of books about IRAs, including Your Complete Retirement Planning Roadmap, says, “Changing the payout schedule is not allowed.”

If it were, you’d naturally be inclined to take out more money in years your IRA has a great return and less when it has a loss. However, the IRS and Tax Court have made it clear time and time again that “IRA” is not synonymous with “ATM.” You cannot use your retirement account as if it were a tax-sheltered saving account.

It’s actually pretty simple: If you want to avoid the 10% penalty for withdrawing IRA funds prior to age 59½, make sure you continue withdrawing $33,280 for another 3 years.

Or, if your goal is to stop the bleeding from your IRA, stop the withdrawals, bite the bullet, and pay the penalty.

Hope this helps,
Gail

2. OK, OK! Three more years of withdrawals actually add up to $99,840.