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Inherited IRA Rules, Pro-Rata Tax Rule Highlight Mailbag

This week's Slott Report Mailbag includes your questions (and our answers) on inherited IRA distributions, SEP IRAs and the pro-rata tax rule. As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure. Find one in your area at this link.


Hello Ed,

Are you able to answer a question related to an inherited IRA?

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Here is the issue. I have inherited an IRA from a deceased brother. It is a modest amount of money, about $25k. I am 55 years old. My brother was a few years younger. My question is this. 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 have a second option on how to take the money from the inherited IRA. You can choose the 5-year rule where the funds must be distributed by December 31 of the 5th year after your brother died. Assuming he died in 2012, the deadline would be 12/31/17. During this 5-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.


I have an IRA worth $130,000 with $2,000 in basis, and this IRA 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 percentage of your distributions for the year that are income tax free. This formula is found in IRS Form 8606. 

-By Joe Cicchinelli and Jared Trexler


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Consumers: Send in Your Questions to [email protected]

I transferred a stock from my IRA to my regular (non IRA account) and then transferred the exact same number of shares of the same stock back into my IRA within 60 days. However, the value of those shares was $10,000 higher.

Do I have a problem because I put more money into the IRA even though I transferred the same number of shares?


There is no problem. Your distribution of property (shares of stock) from your IRA qualifies to be rolled over tax-free within 60 days only if the identical stock is rolled over to a receiving IRA. It is common for the value of stock to change during the 60-day window. That’s OK and still qualifies as a tax-free rollover. When your tax return is filed for the year, your tax preparer may want to attach a note to explain the different values.