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There are two primary ways through which one inherits an individual retirement account (IRA) – being named a beneficiary on the account or through an estate. This piece will focus on the latter, but first, a quick refresher on the former.
Rules for beneficiaries aren’t the same across the board. For example, a wife that’s the beneficiary of her husband’s IRA can roll his account over to hers upon his death, but other non-spousal beneficiaries have 10 years to deplete the inherited account unless they’re eligible designated beneficiaries (EDBs), which Google AI defines as “Spouses, minor children, disabled or chronically ill individuals, and those not more than 10 years younger than the deceased are considered EDBs.”
Alright, now let’s get into some of the details regarding what happens when an IRA is passed down through an estate and if you feel motivated to contact an advisor or tax professional at the end of this piece, don’t worry. You’re not alone and you’re on the right track.
For starters, if an estate inherits an IRA, the distribution rules are applicable to an estate, even if the account is later moved onto an individual. Second, those distribution guidelines are determined by whether or not the accountholder died before or after their required beginning date (RBD). Usually, that’s April 1 in the year following the year in which the investor turned 73.
You’re Not a Designated Beneficiary!
As noted above, the most common avenues for bequeathing an IRA is to a designated beneficiary or to an estate so if you’re a recipient of an IRA that’s moved onto you from an estate you are NOT a designated beneficiary. That means the account holder’s RBD is material and something that should be discussed with an advisor or an accountant.
“If the IRA owner died before the RBD, the account must be fully distributed no later than the fifth year after the year of death. Distributions before then are optional,” notes Denise Appleby of Morningstar. “If the participant died on or after the RBD, distributions must be made over the remaining single life expectancy of the IRA owner. More than the RMD for a year can be taken at any time.”
Appleby outlines two scenarios in which the IRA owner dies before their RBD and after. In the latter scenario, the estate can take distributions from the IRA based on the number of years on the estate’s beneficiary’s life expectancy. Or the funds can be rolled over to an IRA held by one of the beneficiary’s beneficiaries. For example, a mother that doesn’t want to keep the estate open for 15 or 20 years can roll the IRA passed down to the estate to one held by her daughter.
The death-before-RBD scenario is simpler. In that case, the estate must liquidate the inherited IRA within five years and “any remaining balance after that date would be considered an RMD shortfall and subject to a 25% excise tax,” adds Appleby.
How to Make the Decision
Obviously, no one has a crystal ball that informs about their date of death. If that option was available, it’d be reasonable for advisors to tell clients to name individual beneficiaries for IRAs if they know they’ll pass away prior to RBDs and pass the IRA onto an estate if they know they’ll live beyond the RBD.
Still, there are arguably more advantages to naming a beneficiary over a passing the IRA onto an estate, but be sure to check with an advisor or an accountant on that. There’s certainly fewer hoops to jump through for the beneficiary when they’re named rather than having to go through an estate.
“Consider, too, that some IRA custodians will not allow a transfer of assets from an estate to the beneficiary of the estate unless the beneficiary obtains approval from the IRS under a private letter ruling. PLRs incur an IRS fee as well as professional fees,” concludes Appleby.
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