A Look at Inherited IRA's
Naming a beneficiary for your traditional IRA (Individual Retirement Account) need not be a difficult task. Most people choose their spouse, if married, or another loved one. However, the rules governing the distribution of IRA assets to beneficiaries are not so simple. With this in mind, here is a quick look at the Internal Revenue Service (IRS) rules for inherited IRAs.
Taking a Closer Look
The IRS stipulates that an IRA owner must begin taking required minimum distributions (RMDs) by April 1st of the year following the calendar year during which he or she reaches age 70 ½, commonly referred to as the “required beginning date.” IRA beneficiary rules involve two separate issues: 1) the age of the IRA owner at the time of death; and 2) the identity of the IRA beneficiary (the rules for spousal beneficiaries differ from those for non-spousal beneficiaries).
Spousal Beneficiaries
If an IRA owner dies before RMDs have begun, a spousal beneficiary can choose to withdraw all IRA assets within five years, maintain the IRA under the deceased spouse’s name, or treat the IRA as his or her own. Suppose David Thompson dies and his wife, Lee, is the beneficiary of his IRA in David’s name, minimum distributions do not have to begin until December 31st of the later of: 1) the year following the year of David’s death; 2) the year in which David would have reached age 70 ½. However, distributions would be based on Lee’s life expectancy. If Lee chooses to treat the IRA as her own, she is entitled to name new beneficiaries, and the rules governing RMDs would be the same as if the IRA were originally her own. Therefore, distributions would have to begin by April 1st of the year after the year in which she turns 70 ½, and the required amount would be based on her life expectancy.
If David were to die after RMDs had begun, the options for Lee would be different. She could choose to either continue receiving distributions based on David’s life expectancy, or her own life expectancy. As a third option, Lee could opt to roll over David’s assets into her own IRA. (This option is not available for IRAs that have been annualized.)
Non-Spousal Beneficiaries
Non-spousal beneficiaries have fewer options than spouses. Unlike spousal beneficiaries, non-spousal beneficiaries may not treat IRAs as their own, and cannot name additional beneficiaries. If the owner dies before the required beginning date, all assets in the account must be distributed by the end of the year that contains the fifth anniversary of the owner’s death. Alternately, the beneficiary may elect to receive distributions over his or her life expectancy. The amount of distributions is based on the beneficiary’s life expectancy, and must begin by December 31st of the calendar year immediately following the calendar year of the owner’s death.
If the owner dies on or after the required beginning date, the assets musts be distributed over a period not exceeding the larger of the owner’s or the beneficiary’s life expectancy.
Parting Thoughts
Under regulations proposed by the IRS in 2001, and finalized in 2002, beneficiaries may be named as late as September 30th of the year after the IRA owner’s death. Furthermore, a primary beneficiary can disclaim an inheritance, allowing it to pass to a contingent beneficiary. Furthermore, in response to the American population’s increased longevity, the IRS increased life expectancy figures, which essentially reduces required distributions.
If you are an IRA owner or beneficiary, the wide variety of beneficiary arrangements can easily lead to confusion. It is important to be aware of your options and the tax consequences that may apply in your situation.
Taking a Closer Look
The IRS stipulates that an IRA owner must begin taking required minimum distributions (RMDs) by April 1st of the year following the calendar year during which he or she reaches age 70 ½, commonly referred to as the “required beginning date.” IRA beneficiary rules involve two separate issues: 1) the age of the IRA owner at the time of death; and 2) the identity of the IRA beneficiary (the rules for spousal beneficiaries differ from those for non-spousal beneficiaries).
Spousal Beneficiaries
If an IRA owner dies before RMDs have begun, a spousal beneficiary can choose to withdraw all IRA assets within five years, maintain the IRA under the deceased spouse’s name, or treat the IRA as his or her own. Suppose David Thompson dies and his wife, Lee, is the beneficiary of his IRA in David’s name, minimum distributions do not have to begin until December 31st of the later of: 1) the year following the year of David’s death; 2) the year in which David would have reached age 70 ½. However, distributions would be based on Lee’s life expectancy. If Lee chooses to treat the IRA as her own, she is entitled to name new beneficiaries, and the rules governing RMDs would be the same as if the IRA were originally her own. Therefore, distributions would have to begin by April 1st of the year after the year in which she turns 70 ½, and the required amount would be based on her life expectancy.
If David were to die after RMDs had begun, the options for Lee would be different. She could choose to either continue receiving distributions based on David’s life expectancy, or her own life expectancy. As a third option, Lee could opt to roll over David’s assets into her own IRA. (This option is not available for IRAs that have been annualized.)
Non-Spousal Beneficiaries
Non-spousal beneficiaries have fewer options than spouses. Unlike spousal beneficiaries, non-spousal beneficiaries may not treat IRAs as their own, and cannot name additional beneficiaries. If the owner dies before the required beginning date, all assets in the account must be distributed by the end of the year that contains the fifth anniversary of the owner’s death. Alternately, the beneficiary may elect to receive distributions over his or her life expectancy. The amount of distributions is based on the beneficiary’s life expectancy, and must begin by December 31st of the calendar year immediately following the calendar year of the owner’s death.
If the owner dies on or after the required beginning date, the assets musts be distributed over a period not exceeding the larger of the owner’s or the beneficiary’s life expectancy.
Parting Thoughts
Under regulations proposed by the IRS in 2001, and finalized in 2002, beneficiaries may be named as late as September 30th of the year after the IRA owner’s death. Furthermore, a primary beneficiary can disclaim an inheritance, allowing it to pass to a contingent beneficiary. Furthermore, in response to the American population’s increased longevity, the IRS increased life expectancy figures, which essentially reduces required distributions.
If you are an IRA owner or beneficiary, the wide variety of beneficiary arrangements can easily lead to confusion. It is important to be aware of your options and the tax consequences that may apply in your situation.
There are other tax-cutting strategies in addition to those mentioned here. If you would like assistance in selecting tax-saving strategies that make the most sense in your situation, contact us today!