You thought I was kidding when I mentioned, a while back, Canadians massing for an invasion of Maine? Thanks to Eric Jones for steering me to the latest information on Canada’s plans for world domination (“Be afraid,” advises Eric. “Be very afraid!”).

Mark Kennet: “I had understood that heirs to an IRA can inherit the IRA as an IRA. In other words, they may rollover the inherited IRA into a new one, thereby avoiding tax until they begin withdrawal from the account. Is this correct?”

The rules for IRA distributions are so complicated that any general statement is going to get me in trouble. Briefly, though — and with a huge assist from Less Antman, my Taoist tax-accounting guru — if someone dies before age 70 1/2 (when mandatory distributions are to begin), and the beneficiary is the deceased’s spouse, it can just be rolled to the spouse as their own IRA and continue from there.

When the beneficiary is anyone else, however (such as a child, or the lifetime partner of a same-sex couple denied the right to marry), a rollover is not permitted. Instead, the IRA becomes a “beneficiary IRA,” and there are two choices: Start regular distributions over the life expectancy of the beneficiary, or else withdraw everything by the end of the fifth year following the death of the original owner.

For example, if the owner of the IRA dies in 2000, the beneficiary must begin annual distributions over his or her life expectancy by December 31, 2001. If not, then he or she must withdraw the entire IRA by December 31, 2005. The life expectancy tables are part of the Internal Revenue Code and easy to download from the IRS Web site at in Publication 590. A 50-year-old beneficiary has a 33.1 year life expectancy, and will divide the value of the IRA by 33.1 to determine the first distribution. In the following year, they divide the value of the IRA by 32.1, next 31.1, etc.

If the owner had already begun mandatory distributions (died after reaching 70 1/2), then the beneficiary’s options vary widely depending on the elections made by the decedent — “and I would sooner register to vote as a Democrat,” cracks libertarian Less, “than try to explain them in a single e-mail.” But for those who need help with this, Less generously offers it. Just e-mail me the specifics of your situation and I will forward to Less.

And of course it’s not just income tax you have to worry about with a decedent’s IRA.

Say you are the beneficiary of a $1 million IRA, and there is no spouse, and thus no spousal exemption. (You are, say, the child, or the lifetime partner, of the deceased.)

Worst case? $1 million increases the estate tax by $600,000, and withdrawal results in $396,000 federal income tax. That makes $996,000 in taxes, leaving $4,000 net. Unless there are state taxes — even more horrifying.

It may certainly not be this bad. The first $675,000 of a person’s estate is entirely free of federal estate tax, and that exemption is slated to rise gradually to $1 million in 2006. (Separately, there is talk of increasing it to $5 million.) What’s more, the top 55% rate applies only to amounts in excess of $3 million. (Above $10 million, another 5% is added for a while to get even the first $3 million — taxed at rates rising quickly from 18% to 53% — up to the full 55% rate.) So for a $300,000 IRA, say, where the deceased’s other assets are modest, there may well be no estate tax on the IRA, only the income tax on withdrawals.

But the bottom line is that IRAs were designed to be spent in retirement, not inherited. What’s left after the taxpayer and spouse die ought to go to charity if the decedents have enough wealth to be subject to estate taxes. For someone not inclined to give it to charity, it is a good idea to convert the IRA to a Roth IRA if possible, paying the income tax on the conversion. Paying that tax shrinks your wealth, and thus the eventual estate tax. And, once converted, withdrawals from the Roth IRA, whether by you or your beneficiaries, will be free of federal income tax. (If you’re not normally in the top tax bracket, consider spreading the conversion over several years to take maximum advantage of those lower-than-top rates.)

Thanks, Less.


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