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A few years ago, my wife inherited the assets from some sort of retirement account from a deceased relative. At the time, we were less investment-literate than today, so with the aid of a financial planner, the assets were transferred into an individual retirement annuity account in my wife's name, issued by a large insurance company. Each year, she is required to take required minimum distributions from the annuity (I believe due to the age of the relative that she inherited the account from), which show up as taxable income for us (that we don't really need at this point in time).

I would like to avoid the required distributions, obtain greater choice of investments, and in general consolidate our investment picture by moving these assets into a different account structure. It would seem to make sense to roll the assets over into a traditional IRA (she already has one from rolling over a previous employer's qualified retirement plan contributions). Is this possible without significant penalties? I understand that redemption of the annuity has a surrender charge associated with it, but I'm wondering if I can make the move without incurring adverse income tax consequences.

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You are not allowed to take a retirement account and move it into the beneficiary's name, an inherited IRA is titled as "Deceased Name for the benefit of Beneficiary name". Breaking the correct titling makes the entire account non-retirement and tax is due on the funds that were not yet taxed. If I am mistaken and titling remained correct, RMDs are not avoidable, they are taken based on your Wife's life expectancy from a table in Pub 590, and the divisor is reduced by one each year.

Page 86 is "table 1" and provides the divisor to use. For example, at age 50, your wife's divisor is 34.2 (or 2.924%). Each year it decrements by 1, you do not go back to the table each year. It sounds like the seller's recommendation bordered on misconduct, and the firm behind him can be made to release you from this and refund the likely high fees he took from you. Without more details, it's tough to say. I wish you well.

The only beneficiary that just takes possession into his/her own account is the surviving spouse. Others have to do what I first described.

  • I suspected that may be true. This article seems to agree with your assertions also. Looks like it's going to have to stay where it is; turning the entire account into taxable income in one year would be extremely cost-prohibitive. – Jason R Feb 13 '12 at 3:02
  • What exactly was it in when her mom passed? That's what's not clear to me. – JoeTaxpayer Feb 13 '12 at 3:09
  • I do not recall. She inherited the account nearly four years ago, and my memory does not serve me well enough to remember. Her relative had a number of retirement accounts of varying types that have each had to be treated separately; I believe this one may have been a traditional IRA (that we were recommended to convert into this annuity structure), but I'm not sure. – Jason R Feb 13 '12 at 3:11
  • You may be able to make the move, provided the titling is done correctly. An inherited IRA can be transferred between brokers and invested in what you wish, aside from the usual disallowed investments. IRAs are already tax favored, putting an annuity inside an IRA is generally considered ill-advised, what was the reason behind that move? – JoeTaxpayer Feb 13 '12 at 3:18
  • The only reasoning was a recommendation from a financial advisor (who I'm sure cherry-picked the product that was most financially advantageous to him) and our youthful ignorance. I need to track down the contract terms; I'm not sure when/if we are required to start taking larger pieces out. I didn't take much interest in investing until after the events of 2008, and if I had it all to do over again, I would have handled the situation differently. – Jason R Feb 13 '12 at 3:29
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Annuities, like life insurance, are sold rather than bought.

Once upon a time, IRAs inherited from a non-spouse required the beneficiary to

(a) take all the money out within 5 years, or

(b) choose to receive the value of the IRA at the time of the IRA owner's death in equal installments over the expected lifetime of the beneficiary.

If the latter option was chosen, the IRA custodian issued the fixed-term annuity in return for the IRA assets. If the IRA was invested in (say) 15000 shares of IBM stock, that stock would then belong to the IRA custodian who was obligated to pay $x per year to the beneficiary for the next 23 years (say).
There was no investment any more that could be transferred to another broker, or be sold and the proceeds invested in Facebook stock (say). Nor was the custodian under any obligation to do anything except pay $x per year to the beneficiary for the 23 years.

Financial planners loved to get at this money under the old IRA rules by suggesting that if all the IRA money were taken out and invested in stocks or mutual funds through their company, the company would pay a guaranteed $y per year, would pay more than $y in each year that the investments did well, would continue payment until the beneficiary died (or till the death of the beneficiary or beneficiary's spouse - whoever died later), and would return the entire sum invested (less payouts already made, of course) in case of premature death. $y typically would be a little larger than $x too, because it factored in some earnings of the investment over the years. So what was not to like? Of course, the commissions earned by the planner and the lousy mutual funds and the huge surrender charges were always glossed over.

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