She chose to roll the full amount into an IRA in her own name.
Not long afterward, Lucy withdrew $977,888. She reported the distribution as taxable income but did not include the 10% early-withdrawal penalty because she believed she still qualified for the exception available to beneficiaries. That was a rollover mistake.
The IRS saw it differently.
The case eventually reached the U.S. Tax Court, where her argument was rejected. The court explained:
“Once [Lucy] chose to roll the funds over into her own IRA, she lost the ability to qualify for the exception from the 10-percent additional tax on early distributions. The funds became petitioner’s own and were no longer from her deceased husband’s IRA once petitioner rolled them over into her own IRA.”
The result was a penalty of nearly $100,000, on top of the income tax she already owed. Big rollover mistake. It’s only one of a number of decisions retirees, and those planning for retirement, face.
The problem was not necessarily the rollover itself. It was the timing of the rollover and the loss of planning flexibility that came with it.
Surviving spouses have special options that other IRA beneficiaries do not. Those choices can affect access to the money, required distributions, future tax bills and whether withdrawals before age 59½ are subject to an additional penalty.
Once the wrong move is made, there may be no practical do-over.
This is where the “99% rule” may help bring some much-needed clarity. It is not a formal IRS rule, but rather a planning concept that can help surviving spouses think more carefully before moving an inherited IRA.
Do you know the 99% rule? You can learn more about it here.
Enjoy!
Jim
