Life and Death Planning for Retirement Benefits

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Life and Death Planning for Retirement Benefits

Inherited IRAs are not aggregated with the beneficiary’s own IRA(s) for purposes of determining how much of any distribution from either type constitutes tax-free return of basis. If a beneficiary inherits IRAs from more than one decedent, he must track basis separately for the IRAs he inherited from each decedent. The one exception to these statements applies to the surviving spouse—if she elects to treat an IRA she has inherited from the deceased spouse as her own IRA or rolls it over into her own IRA (see ¶ 3.2 ), the basis in the decedent’s IRA is just added to hers. An individual must file separate Forms 8606 for his own IRAs vs. IRAs he holds as beneficiary (and for IRAs held as beneficiary of different decedents); this is stated in IRS Publication 590-B (2016), p. 5; see Instructions for IRS Form 8606 (2016), p. 1. Inherited traditional IRAs are not aggregated with inherited Roth IRAs for any purpose. See ¶ 5.2.03 (B). Distributions from traditional IRAs are taxed under the cream-in-the-coffee rule of § 72 ( ¶ 2.2.02 ) unless an exception applies. § 408(d)(2) ; § 72(e)(2)(B) , (5)(A) , (5)(D)(iii) , and (8)(B) . For the exceptions see ¶ 2.2.10 . For taxation of distributions from a Roth IRA see ¶ 5.2.03 . A special aggregation rule applies to IRAs that does not apply to other plans: For purposes of determining how much of any particular distribution is a return of the participant’s basis, all of the participant’s (noninherited) IRAs are treated as a single giant IRA (aggregation of accounts; see “F” below) and all distributions during the year from the aggregated accounts are treated as one single distribution (see “B”). Since the conversion of funds from a traditional to a Roth IRA is treated as a distribution from the traditional IRA ( ¶ 5.4.03 ), these same aggregation rules are used to determine how much income a participant realizes when he converts funds from a traditional IRA to a Roth IRA. Reg. § 1.408A-4 , A-7(a). Here is the formula for determining how much of a particular year’s distributions from (and Roth conversions of) traditional IRAs constitutes tax-free return of the participant’s investment in the contract (basis), adapted from Notice 87-16, 1987-1 CB 446, Part III. The taxable portion of traditional IRA distributions and of Roth conversions of traditional IRAs are figured on different parts of IRS Form 8606 using this formula. A. The cream-in-the-coffee formula. The total amount of the participant’s IRA distributions for the year is multiplied by a fraction. The numerator of the fraction is participant’s total basis in the aggregated accounts (“Nondeductible Contributions”; see “D”). The denominator is the [total balance of all his traditional IRAs as of the end of the year in which the distribution occurs] plus [the Distribution Amount]. How much of a traditional IRA distribution is basis?

Return of Basis = [Distribution Amount] X [The Fraction]

The Fraction is:

Total Nondeductible Contributions [Year-End Account Balance + Distribution Amount + Outstanding Rollovers]

The following paragraphs explain the components of this formula and how it works.

B. Distribution Amount. The Distribution Amount figures into the formula twice, once as part of the denominator of The Fraction and once as the multiplicand. Basically, the