Which beneficiary pays income tax on IRA? All three

Personal Finance editor HELEN HUNTLEY E-mail: Click here Archive

By HELEN HUNTLEY

© St. Petersburg Times, published June 25, 2000

Q. My husband was one of three beneficiaries on his mother's individual retirement account. After she died, the credit union that had the IRA divided the money three ways and sent each beneficiary a check for about $9,400. Do we claim this as an IRA distribution on our tax form or will this be non-taxable as a gift below 10,000? Whose tax ID number will it be reported under?

I have spoken to many people and gotten a lot of guess and different opinions, leaving me very confused.

A. This is just one of many confusing things about IRAs. The short answer is that each beneficiary is responsible for reporting and paying income taxes on his or her share of the distribution.

If your mother-in-law made any non-deductible contributions to her IRA, then part of each distribution will be tax-free, representing the return of her after-tax contributions. Otherwise, it is all taxable, just as it would have been had your mother-in-law withdrawn it during her lifetime.

This may not apply to you, but IRA expert Ed Slott says you do get a break on your return if your mother-in-law filed a federal estate tax return.

"There may be a big overlooked tax deduction," he said. "If the mother's IRA was subject to federal estate tax, then each of the beneficiaries would be entitled to deduct a share of that federal estate tax on their personal tax returns for the year that they report the inherited IRA distribution."

If your mother-in-law filed an estate tax return, check to see if estate tax was paid on the IRA.

"Often, the deduction is so large that beneficiaries who normally would not have enough deductions to itemize, now are able to," said Slott, an accountant in Rockville Centre, N.Y., who publishes a newsletter on IRAs.

Q. What do you think about the Marketplace Banks that are showing up in Winn-Dixies? The interest rates are great. I was told you would receive monthly statements and this is insured by the FDIC even though this is a Canadian banking company. I asked my bank to match these rates and they cannot.

A. Marketplace Bank is a trademark used by CIBC National Bank, which is an FDIC member. As long as you deal with FDIC member banks and stay within the limits of FDIC insurance coverage, you have no reason to worry about using any bank.

I do not recommend any particular bank. What I recommend is that you analyze what you need from a bank and look for one that best meets your needs for products, service and convenience.

Some people prefer to use one bank for maximum convenience, while others will use more than one if it means they get access to a product or service they really want.

Q. I turn 62 soon and will begin receiving monthly payments from my previous employer's retirement fund. This is a 100 percent vested rights payment. My question is this: Is it possible to have this monthly payment go directly to my IRA fund without being taxed? I am participating in my current employer's 401(k) program and will contribute the maximum this year ($10,500). Does that make a difference?

A. Monthly payments from a retirement plan cannot be rolled over to an IRA. A lump sum distribution can be rolled over, so if your employer offers that option, you might consider it. If you are eligible for a lump sum distribution, have your employer transfer the money directly to an IRA to avoid having 20 percent withheld for taxes.

Q. I have several Series E savings bonds that will stop drawing interest in 2004. I would like to defer the interest another seven to 10 years. Could I exchange these bonds for the relatively new I bonds or other types of government bonds?

A. You have one choice if you want to exchange your bonds: You can trade them in for HH bonds but you will only earn 4 percent interest. That means you would be better off cashing the bonds and reinvesting the money elsewhere at a better rate.

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- Helen Huntley writes about investing and markets for the Times. If you have a question about investments or personal finance, send it to On Money. We'll try to answer those we think are of greatest reader interest. All questions must be submitted in writing, but readers' names will not be published. Send questions to Helen Huntley, Times, P.O. Box 1121, St. Petersburg, FL 33731, or to huntley@sptimes.com by e-mail.

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