Ed Slott was named "The Best" source for IRA advice by The Wall Street Journal and called "America's IRA Expert" by Mutual Funds Magazine. He is a widely recognized professional speaker and educator specializing in retirement distribution planning, teaching both financial advisors and consumers how to best take advantage of our complicated tax code.

-- Have something you want to ask Ed? Send your questions to mailbag@irahelp.com

IRA expert Ed Slott explains when and why it’s best to use the five-year rule for distributions from an inherited IRA.

Question 1:

Hello Ed,

Are you able to answer a question related to an inherited IRA? Here is the issue:

I have inherited an IRA from a deceased brother. It is a modest amount of money, about $25,000. I am 55 years old. My brother was a few years younger. Must I begin to take an annual distribution immediately or should I wait until after age 59.5? Once I begin to take my distributions, are the minimums determined by my age or my deceased brother's age?  And lastly, is there a penalty for distributions before I turn 59.5.

Thanks for your enlightened guidance.



Generally you MUST begin taking required distributions from an IRA that is inherited from someone other than your spouse beginning in the year after the death of the account owner. You use your single life expectancy using your age as of the end of the year. This option is often called a stretch IRA. There is never a penalty when taking distributions from an inherited IRA regardless of your age.

You also have a second option on how to take the money from the inherited IRA. You can choose the five-year rule where the funds must be distributed by Dec. 31 of the fifth year after your brother died. Assuming he died in 2012, the deadline would be 12/31/17.  During this five-year period, you can take the money out however you’d like. There is no penalty as long as the account is emptied by the end of the fifth year.

Question 2:

I have an IRA worth $130,000, with $2,000 in basis, which does not receive contributions. I also have a much larger SEP that receives regular contributions. Can I move $128,000 of IRA into the SEP and just yank the $2,000 IRA balance without tax consequences?



Whether you can move non-SEP money into your SEP depends on the custodian. The IRS allows it but some custodians insist on keeping SEP money separate from other IRA funds.

You cannot just take the $2,000 basis tax-free because of the pro-rata tax rule that applies to IRAs. Basically, you or your CPA must add together the balances of all your IRAs, including any SEP and SIMPLE IRAs. Then, you take all your basis and divide it by the total of all the balances in all your IRAs. The percentage you get is the percent of your distributions for the year that are income-tax free. This formula is found in IRS Form 8606. 

-- Have something you want to ask Ed? Send your questions to mailbag@irahelp.com





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