IRAs are becoming a common asset in estate plans, sometimes the largest asset
of the estate. They can, however, be a tax trap for the unwary. Inherited IRAs
are treated differently depending on the age of the decedent and who inherits the
Treatment of an IRA varies depending on whether the owner died before he was
to take the Required Minimum Distributions (RMDs) (age 70 ½) or during the RMD period. There are four possible beneficiary designations. The beneficiary can be a spouse, a non-spouse, both a spouse and non spouse or no beneficiary named. Let us examine how distributions would be handled in each possible situation.
Spouse as Beneficiary
A spouse has four options with respect to the inherited IRA:
1. Roll over – A spouse can roll over the IRA into her own existing or new
IRA. She can name her own beneficiaries, continue contributing to this
IRA and need not begin RMDs until she, herself, is 70 ½.
2. Remain a beneficiary – On the other hand, the spouse can treat the
IRA as a beneficial or inherited IRA and continuing the distribution pattern
of the deceased owner. This might be advantageous if the surviving
spouse is much older than the deceased spouse or is younger than 59 ½
and wishes to take distributions without penalty.
3. Cash out the IRA – Amounts withdrawn would be immediately taxable.
4. Disclaim or give away the account – If the spouse was well off
financially, she might choose to forego her right to receive the IRA and
allow it to pass to the contingent beneficiaries. Doing so would spare her
the income tax when the account is withdrawn and might spare her
children additional estate tax when she dies. A disclaimer must be done
within nine months of the date of death.
Non-spouse as Beneficiary
Before RMD – When the owner has named someone other than the spouse or
someone in addition to the spouse as primary beneficiary, the distribution will
need to be made within 5 years of the last day of the year of the owner’s death,
unless the beneficiary elects to take distribution over a period not exceeding his
or her own life expectancy. If there are multiple beneficiaries, the life expectancy of the oldest will be used. To avoid this, the beneficiaries may segregate the IRA account so each can use his own life expectancy. It is especially important to
separate the IRA if one of the beneficiaries is a charity as such entities have no life expectancy and must distribute within 5 years.
During RMD – If the owner was already receiving RMDs, the remaining
distributions must continue to be made in the same way and cannot be spread
over a longer life expectancy. Non spouses must keep the inherited IRAs totally
separate from other funds and cannot make additional contributions to the
No Beneficiary Named
If no beneficiary is named or the named beneficiary has predeceased, the IRA
distribution will go to the owner’s probate estate.
Before RMD – Since the estate has no life expectancy, the entire IRA would
need to be distributed no later than the last day of the 5th year following the owner’s death. The administrator of the estate has two options:
(1) he could maximize the tax deferral by waiting until the end of the 5 year period to withdraw all of the money or
(2) he could spread the distributions out over the five year
period and spread out the tax liability.
During RMD – The estate administrator would have no option but to follow the predetermined plan of the deceased owner. If the IRA owner was taking withdrawals over the term of his life expectancy, this would be continued by the estate beneficiaries.
Inheriting an IRA can be a real windfall, but it is important to understand and consider the options available to take the best tax advantages. Discuss your options with your attorney and accountant immediately as the timing of elections is critical.
IRA owners should consider the ramifications of their choice of primary and contingent beneficiaries on their family and loved ones. Those with a charitable intent might consider designating a charity as beneficiary since charities pay no income tax on the IRA. Designating IRA beneficiaries is an important part of your estate plan and should be discussed with your attorney and your accountant.