Inherited IRAs come with RMD strings attached

Q: My sister, who was two years older than  me, died in 2003 leaving a small IRA for my nephew, my niece and myself. The distribution in writing was 50% for me and 25% each for my niece and nephew.

The financial institution distributed 33% to both niece and nephew. Upon protest, by me, they were requested to return the difference before I could be credited with my share.

I then inquired about the tax implications and was told that I would pay ordinary federal tax upon withdrawal. I recently received a letter informing me that if I don't take my required minimum distribution for 2016 I will be penalized. (I have never taken any monies from the IRA.) I also received a second pamphlet about “inherited IRAs for non-spouses.”

My financial institution now informs me that I will need to have a CPA calculate the penalties and send same to the IRS. What can I do? Should the institution be responsible for calculating the penalties and paying them since I was never informed of this tax implication? — Delroy Falloon, Florida

A: First the bad news. All non-spouse beneficiaries are required to begin taking required distributions in the year after the account owner’s death, says Beverly DeVeny, chief IRA analyst for Ed Slott and Co.

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That means you should have taken your first RMD from the inherited IRA in 2004, says DeVeny. What’s more, DeVeny says there’s a penalty of 50% of any amount not taken when you miss all or part of a required distribution.

Now for the good news. “The IRS can waive the 50% penalty for good cause,” says DeVeny.

To fix the problem of the missed distributions, you’re going to have to crunch some numbers; you’ll need to calculate the distribution for each year from 2004 through 2015, says DeVeny.

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And to do that, you’ll need the prior year-end account statements for each year. Next, she says, you will then have to take all of those distributions from the inherited IRA. Unfortunately, those distributions will be taxable to you in the year you take the distributions. Once the distributions have been taken, you will need to file IRS Form 5329 for each of those years, says DeVeny.

“On this form you will tell IRS how much the distribution was for the year and indicate that you are requesting a waiver of the penalty,” she says. “The form can be filed as a stand-alone tax return. You will need to attach a note to the return explaining why you did not take the distribution and that you are requesting a waiver.”

Do note: Because this form is considered a stand-alone return, the statute of limitations on the penalty does not start to run until you file the form, says DeVeny.

One last bit of bad news. Under the tax code, you — not your financial institution — are responsible for knowing the IRA rules and for making sure that all required distributions are timely made. “IRA custodians are required to let IRA owners know about their required distributions after reaching age 70½ but they are not required to notify IRA beneficiaries of any required distributions,” says DeVeny.

One ray of hope: If the institution gave you the wrong information then you might have some recourse against them, says DeVeny.

Robert Powell is editor of Retirement Weekly, contributes regularly to USA TODAY, The Wall Street Journal and MarketWatch. Got questions about money? Emailrpowell@allthingsretirement.com