Inheriting an IRA

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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 whom you wish to inherit your inherited IRA.

You can also choose not to inherit the IRA; known as "disclaiming" the assets. This may be useful if you wish the benefits to go to someone else or don't want to pay taxes on the assets.[1][note 1]

IRA Inherited from your spouse

Spousal Inheritance of an IRA

You will only be considered to have chosen to treat the IRA as your own if:

  • You are the sole beneficiary of the IRA, and
  • You have an unlimited right to withdraw amounts from it. [2]

You will be considered to have chosen to treat the IRA as your own if:

  • Contributions (including rollover contributions) are made to the inherited IRA, or
  • You do not take the required minimum distribution for a year as a beneficiary of the IRA. [3]


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. [4]

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.[note 2]
  2. With a spousal rollover, the surviving spouse can use the IRS Uniform 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. [5]

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. [4]

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). Executors 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:

  1. Select a fiduciary of choice for investing the inherited IRA;
  2. Possess the capability of executing their own individual investment plan and account succession;
  3. Have the option of taking required minimum distributions from the IRA over their individual life expectancy.[6]

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. [7]

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. [8]

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. [9]

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. [10]

IRA inherited by the estate

"The more favorable RMD rules permitting calculation based on life expectancy are not available if the beneficiary is the owner's estate, a charity, or other organization. An entity beneficiary usually may use the five-year rule if the account owner died before RBD and may calculate RMD as the original IRA owner had during his or her lifetime, if the owner died after his or her required beginning date (RBD). If an entity is one of a group of beneficiaries, the individual beneficiaries may not be able to use their own life expectancies to calculate RMD unless the entity receives a lump-sum distribution or disclaims prior to September 30 of the year following the year of the account owner's death or unless separate accounts are established by all the beneficiaries by December 31 of the year following the year of the owner's death.."
-- Vanguard.com

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. [11]

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. [12]

Advanced beneficiary options

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

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 the fiduciary 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. [13]

Federal estate tax deduction

Federal Estate Tax on Income in Respect of a Decedent.

"This is becoming an increasingly important deduction as more and more taxpayers inherit money in company retirement plans or traditional IRAs. Such amounts are considered "income in respect of a decedent" because the decedent had a right to the income at the time of death, but the income is not included on the person's final tax return. Instead, the beneficiary is taxed on the amounts. You might also deserve a deduction, though, if the decedent's estate was large enough to pay federal estate taxes. Say, for example, that you inherit a $50,000 IRA which, because it was included in your mother's taxable estate, boosted the estate tax bill by $20,500. Although you have to pay tax as you pull money out of the IRA, you also get a deduction for that $20,500. If you pull the full $50,000 out at once, you'd get the full deduction. If you pull it out equally over two years, you'd deduct $10,250 each year. This miscellaneous deduction is not subject to the 2% limit but it's up to you to know the rules to take advantage of them."

-- Tax Tips From TurboTax


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.


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.

Inherited IRA with a basis

When an IRA owner passes with IRA basis documented on Form 8606, the remaining basis is inherited by the beneficiary in proportion to the beneficiary interests.[15]

If the beneficiary is a surviving spouse who rolls the IRA over to their own name or defaults to ownership by perhaps missing an RMD, the inherited basis is added to any basis the surviving spouse may have in their own IRA.

The surviving spouse would then file their own 8606 which would result in their RMDs or other distributions being partially tax free. If the IRA is maintained in inherited form, any basis in the inherited IRA would have to be kept separate from any basis the surviving spouse has in their own IRA by filing an 8606 for each labeled "owned IRAs" or "inherited IRA".

Notes

  1. Should you decide to disclaim in full or partial, note that taking the year of death RMD does not constitute acceptance of the IRA, so you can still take the year of death RMD and then disclaim. This is LIMITED to the year of death RMD, and there are still other formal requirements for a qualified disclaimer. You do not all have to disclaim or disclaim the same amount, but future equitable accounting may become complicated if any of you diverge: How and Why to Disclaim an IRA.pdf
    However, doing it this way can be complicated. It's simpler to do the disclaimer first, and then for the beneficiaries (determined after the disclaimer) to set up separate inherited IRAs and take the distributions pro rata.
    Ref: Inherited IRA decision, direct link to post.
  2. In the first year of ownership, you must take the deceased owner's RMD for that year (to the extent it was not already distributed to the owner before his or her death). Ref: IRS Publication 590

See also

References

  1. Disclaiming Inherited Plan Assets, from Investopedia
  2. Natalie Choate, Life and Death Planning for Retirement Benefit,6th Edition, p. 169. ISBN 0-9649440-7-3
  3. Natalie Choate, Life and Death Planning for Retirement Benefit,6th Edition, p. 170. ISBN 0-9649440-7-3
  4. 4.0 4.1 IRS Pub. 590-B page 5, Viewed May 22, 2016.
  5. Natalie Choate, Life and Death Planning for Retirement Benefit,6th Edition, pp. 164-165. ISBN 0-9649440-7-3
  6. Natalie Choate, Life and Death Planning for Retirement Benefit,6th Edition, pp. 91-95. ISBN 0-9649440-7-3
  7. Natalie Choate, Life and Death Planning for Retirement Benefit,6th Edition, p. 90. ISBN 0-9649440-7-3
  8. Natalie Choate, Life and Death Planning for Retirement Benefit,6th Edition, p. 73. ISBN 0-9649440-7-3
  9. Natalie Choate,Life and Death Planning for Retirement Benefit,6th Edition, p. 90. ISBN 0-9649440-7-3
  10. Natalie Choate, Life and Death Planning for Retirement Benefit,6th Edition, p 75. ISBN 0-9649440-7-3
  11. Natalie Choate, Life and Death Planning for Retirement Benefit,6th Edition, pp. 89-90. ISBN 0-9649440-7-3
  12. Natalie Choate, Life and Death Planning for Retirement Benefit,6th Edition, pp. 357-359. ISBN 0-9649440-7-3
  13. IRA Inheriting Deadlines Vanguard.com.
  14. Natalie Choate, Life and Death Planning for Retirement Benefit,6th Edition, p 125. ISBN 0-9649440-7-3
  15. From forum member Alan S. Also see: [Publication 590-B (IRA with basis)

External links