A deceased customer’s non-spouse IRA beneficiary came into our bank to close out the IRA. On request, we cut a check to the beneficiary and coded it as a death distribution in our system. The beneficiary’s bank had misinformed them that they should obtain and deposit the check to roll the funds over into a beneficiary IRA account and the beneficiary’s bank, which they did. This bank now realizes that it should have done a trustee-to-trustee transfer of the funds. It wants to send us transfer papers and have us change the coding in our system from a death distribution to a trustee-to-trustee transfer to avoid us issuing a form 1099-R reflecting the death distribution, which would result in a sizeable tax burden for the beneficiary. Can we make this change if the other bank agrees to sign a hold harmless agreement protecting our bank?

No, we do not recommend signing the transfer papers or changing the coding in your system. We also caution that a hold harmless agreement might not protect you from potential IRS penalties if you purport to make a trustee-to-trustee transfer of the IRA funds after making a death distribution to the beneficiary.

We spoke with a consultant at Ascensus (an IBA preferred vendor), and they advised that from a compliance perspective, the transaction that occurred when you cut a check to the IRA beneficiary — i.e., an IRA death distribution — cannot be undone. They also noted that if the beneficiary is audited, there could be potential penalties for your bank and the beneficiary’s bank if you attempt to “undo” the death distribution that was made to the beneficiary.

When a non-spouse beneficiary inherits a traditional IRA, they cannot make any contributions to the IRA, but they “can make a trustee-to-trustee transfer as long as the IRA into which amounts are being moved is set up and maintained in the name of the deceased IRA owner for the benefit of” the beneficiary. The Ascensus consultant noted that the beneficiary’s bank should have coded the funds as a contribution. Since a non-spouse beneficiary is not entitled to make contributions to an inherited IRA, the contribution would be considered an “excess contribution.”

The consultant stated that the only way to “fix” the excess contribution would be for the beneficiary to withdraw the funds from the inherited IRA, which would be subject to income tax. Any interest earned on the excess contribution also would be subject to a 10% penalty, but the funds from the death distribution would be entitled to an exemption from the 10% penalty.

Regarding your bank’s responsibilities, we believe you should proceed with issuing a form 1099-R next year reflecting that a death distribution was made.

For resources related to our guidance, please see:

Illinois.bank, Preferred Vendors (Ascensus contact: Mike Bush, (218) 825-5220)

IRS, Publication 590-A (2021), Contributions to IRAs — Inherited From Someone Other Than Spouse (“If you inherit a traditional IRA from anyone other than your deceased spouse, you can’t treat the inherited IRA as your own. This means that you can’t make any contributions to the IRA. It also means you can’t roll over any amounts into or out of the inherited IRA. However, you can make a trustee-to-trustee transfer as long as the IRA into which amounts are being moved is set up and maintained in the name of the deceased IRA owner for the benefit of you as beneficiary. See Pub. 590-B for more information. Like the original owner, you generally won’t owe tax on the assets in the IRA until you receive distributions from it. You must begin receiving distributions from the IRA under the rules for distributions that apply to beneficiaries.”

IRS, Publication 590-A (2021), Contributions to IRAs (“Generally, an excess contribution is the amount contributed to your traditional IRAs for the year that is more than the smaller of: [1] $6,000 ($7,000 if you are age 50 or older), or [2] Your taxable compensation for the year. The taxable compensation limit applies whether your contributions are deductible or nondeductible. An excess contribution could be the result of your contribution, your spouse's contribution, your employer's contribution, or an improper rollover contribution.”)

IRS, Retirement Topics – Exceptions to Tax on Early Distributions (Most retirement plan distributions are subject to income tax and may be subject to an additional 10% tax. Generally, the amounts an individual withdraws from an IRA or retirement plan before reaching age 59½ are called ‘early’ or ‘premature’ distributions. Individuals must pay an additional 10% early withdrawal tax unless an exception applies.”)

IRS, Retirement Topics – Exceptions to Tax on Early Distributions — Exception to 10% Additional Tax (“The distribution will NOT be subject to the 10% additional early distribution tax in the following circumstances: . . . after death of the participant/IRA owner.”)

Form 1099-R (“Box 7. The following codes identify the distribution you received. For more information on these distributions, see the instructions for your tax return. Also, certain distributions may be subject to an additional 10% tax. See the Instructions for Form 5329. . . . 4—Death.”)

Instructions for Forms 1099-R and 5498 (2022), Table 1. Guide to Distribution Codes (4—Death. Use Code 4 regardless of the age of the participant to indicate payment to a decedent's beneficiary, including an estate or trust.”)