Inheriting an IRA

If you inherit a traditional IRA, you are called a beneficiary. A beneficiary can be any person or entity the owner chooses to receive the benefits of the IRA after he or she dies. Beneficiaries of a traditional IRA must include in their gross income any taxable distributions they receive. In almost all cases, it is advantageous to name the primary and contingent beneficiaries you wish to inherit your IRA.


 * RMD Suspended for 2009
 * "If you're over age 70½, you won't have to take required minimum distributions (RMDs) in 2009 from your tax-deferred retirement accounts under new legislation signed by President Bush.
 * The 2009 RMD suspension applies to traditional IRAs, 401(k)s, 403(b)s, and other defined contribution plans. The suspension also applies to investors under age 70½ with inherited IRAs or inherited retirement plan accounts that would otherwise be subject to RMDs."--Vanguard News release, December 23, 2008

IRA Inherited from your spouse
If you inherit a traditional IRA from your spouse, you generally have the following three choices. You can:
 * 1. Treat it as your own IRA by designating yourself as the account owner.
 * 2. Treat it as your own by rolling it over into your traditional IRA, or to the extent it is taxable, into a:
 * Qualified employer plan,
 * Qualified employee annuity plan (section 403(a) plan),
 * Tax-sheltered annuity plan (section 403(b) plan),
 * Deferred compensation plan of a state or local government (section 457 plan), or
 * 3. Treat yourself as the beneficiary rather than treating the IRA as your own.

There are a number of clear advantages to spousal rollovers of an IRA.
 * 1) By using a spousal rollover, the surviving spouse can use his/her own age and life expectancy for starting Minimum Required Distributions from the IRA. Often this can mean a longer period for tax deferral of the IRA.
 * 2) With a spousal rollover, the surviving spouse can use the IRS Unified Lifetime Table, based on joint life expectancies, rather than the Single Life table used for non-spousal beneficiaries of an IRA. The joint tables provide for a slower payout of required minimum distributions.
 * 3) A spousal rollover allows a surviving spouse to name primary and contingent beneficiaries to the IRA. This allows the surviving spouse, if the situation warrants, to correct any problems in the original beneficiary designations. Naming beneficiaries for the spousal IRA can provide these beneficiaries with the option of using their own life expectancies for drawing down the IRA once they inherit it. If the spouse opts to inherit the IRA rather than executing a rollover, the distribution of the IRA must be distributed over the life expectancy of the original deceased owner for all beneficiaries who inherit the IRA.

A spouse, however, might decide to forgo a spousal rollover if he/she is under the age of 59 and 1/2 and has a clear need for the income from the IRA. As beneficiary, the surviving spouse is required to take minumum distributions from the account. Withdrawals would be exempt from the 10% early withdrawal penalty tax.

IRA inherited from someone other than your spouse
If you inherit a traditional IRA from anyone other than your deceased spouse, you cannot treat the inherited IRA as your own. This means that you cannot make any contributions to the IRA. It also means you cannot 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.

Like the original owner, you generally will not 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 (required minimum distributions are determined by the IRS Single Life Expectancy table, see IRA Distribution Tables). Beneficiaries have until December 31 of the year following the death of the decedent owner to properly title and distribute the IRA to the beneficiaries. Multiple beneficiaries should split the IRA into separate interests so that each beneficiary can:
 * Select a fiduciary of choice for investing the inherited IRA;
 * Possess the capability of executing their own individual investment plan and account succession;
 * Have the option of taking required minimum distributions from the IRA over their individual life expectancy.

If an IRA having multiple beneficiaries is not split into separate accounts, the required minimum distribution is based on the life expectancy factor for the oldest beneficiary.

If you establish multiple inherited IRAs you can make tax-free transfers between the inherited IRAs. Although the RMD must be figured on each individual inherited IRA, the RMD can be taken from any of the IRAs.

Should you inherit IRA's from more than one individual, the inherited IRAs cannot be commingled or aggregated. Transfers between IRAs and RMD calculations must be made within each group of inherited IRAs.

An inheritor of an IRA can, and should, name primary and contingent beneficiaries to the inherited IRA. The inherited IRA will always retain the required minimum distribution schedule for the original inheritor.

IRA inherited by the estate
If one does not name beneficiaries to the IRA, the IRA will be inherited by the decedent's estate and will be distributed to the beneficiaries established by will or intestacy law. An estate executor can still designate an inherited IRA to the beneficiaries, as long as this is completed by December 31 of the year following the decedent's death. Here is a sample Fiduciary Letter Transferring Plan Account to Beneficiary which estate executors can use to properly execute the transfer of the inherited IRA to beneficiaries.

If the estate remains the IRA beneficiary, the IRA must be distributed according to the following rules:
 * If the IRA owner has started taking required minimum distributions, the IRA must be distributed at least as quickly as the decedent's remaining required minimum distributions.
 * If the IRA owner is not taking required minimum distributions the IRA must be distributed according to the five-year rule. Under the five-year rule, the assets must be distributed by December 31 of the fifth year since the retirement account owner's death.

IRA inherited by a charity
Since a Traditional IRA contains a tax liability to the government, it is an attractive account for making a charitable contribution for those desiring to leave charitable bequests. Since a charity pays no income tax on its received gifts, and the testamentary contribution is an Estate Tax deduction, making a full or partial beneficial gift of an IRA balance is often reasonable, especially if the remaining estate is in a taxable account, receiving step-up valuation at death, and/or resides in tax-free Roth IRA accounts. It is often advised to keep planned charitable IRA contributions in a separate IRA. Using separate IRAs is the safest route as it assures that individual beneficiaries can use lifetime required minimum distribution of the inherited IRA. A fractional beneficiary designation that includes both individual and charitable beneficiaries can be split by distribution of the charitable interest by September 30 of the year following the death of the IRA owner, or by the establishment of separate accounts by December 31 of the year following the IRA owner's death and allow individual lifetime distribution, but only if the the deadlines are met.

Advanced Beneficiary Options
These beneficiary options require the services of a qualified estate planner.


 * Naming a revocable or testamentary trust as IRA beneficiary;
 * Disclaiming an IRA (see Disclaiming Inherited IRAs - TIAA-CREF);
 * Naming a Charitable Remainder Trust, Donor-Advised Fund, or Charitable Gift Annuity, as IRA beneficiary.

Deadlines
Here are key dates you should keep in mind to make sure you meet the IRS deadlines that apply to the options you choose.


 * December 31 of the original account owner's year of death. If the account owner died on or after his or her required beginning date (RBD), the RMD for the year must be satisfied if it was not taken in full during the account owner's lifetime.
 * December 31 of the year following the original account owner's year of death. If you are taking RMD based on the life-expectancy method, distributions must begin by this date. If you are one of multiple beneficiaries, all beneficiaries must have established separate inherited IRA accounts by this date in order to calculate distributions based upon each beneficiary's own life expectancy.
 * September 30 of the year following the original account owner's year of death. Important for determining the beneficiary whose life expectancy may be used to calculate RMD (the designated beneficiary). If you're one of multiple beneficiaries of varying ages, all beneficiaries must use the life expectancy factor of the oldest beneficiary who has not taken a lump-sum distribution or disclaimed his or her entire interest prior to this date. However, if all of the beneficiaries have established separate IRA accounts by December 31 of the year following the account owner's death, then all beneficiaries may be able to use their own life expectancy factors to calculate their RMD. Check with your tax advisor to see if you are eligible for this benefit.
 * October 31 of the year following the account owner's year of death. Important if you are the trustee of a trust named as IRA beneficiary. The IRS mandates that trustees provide Vanguard with a copy of the trust document or a summary list of the trust's beneficiaries and conditions by this date. If this requirement is not met, or if the trust failed to meet certain other IRS requirements, it's not considered a qualifying trust eligible for more favorable RMD calculations, usually based on the life-expectancy of the oldest trust beneficiary.
 * Within nine months after the original account owner's death. If you're planning to disclaim the assets, your written disclaimer generally must be received no later than nine months after the date on which you become entitled to the assets, according to IRS regulations.

Federal estate tax deduction
A beneficiary may be able to claim a deduction for estate tax resulting from certain distributions from a traditional IRA. The beneficiary can deduct the estate tax paid on any part of a distribution that is income in respect of a decedent (IRD). He or she can take the deduction for the tax year the income is reported. The deduction is taken by the beneficiary receiving the IRD, not the beneficiary who pays the estate tax.

"Jack Example: Jack dies in 2002 with an estate of $3 million. He leaves his $1 million IRA (which is entirely IRD) to his daughters Jill and Holly. He leaves his $2 million probate estate (which is not IRD) to his son Alex. Alex pays the federal estate tax of $897,500. The [section 691(c) IRD] deduction goes equally to Jill and Holly because they received the IRD, even though Alex is the one who paid the estate tax."

Any taxable part of a distribution that is not income in respect of a decedent is a payment the beneficiary must include in income. However, the beneficiary cannot take any estate tax deduction for this part.

A surviving spouse can roll over the distribution to another traditional IRA and avoid including it in income for the year received.

Links

 * IRS Final Regulations 26 CFR Parts 1, 54, and 602
 * Natalie Choate: Ataxplan Publications
 * Morningstar Advisor: Retiring With Natalie Choate
 * Vanguard: Inherited IRA–Spouse as beneficiary
 * Vanguard: Inherited IRA–Nonspouse as beneficiary
 * Investopedia: Disclaiming Inherited Plan Assets