In this post, we discuss what specifically happens when an IRA account holder dies. What choices does the individual beneficiary have?
Here, we’ll start with the individual (i.e. human being) beneficiary’s options for distributing Traditional or Roth IRAs (other types of IRAs, such as SEP IRAs, SIMPLE IRAs, and Self-directed IRAs, are beyond the scope of this topic). At another time, we’ll discuss the rules if the IRA owner instead chose an entity beneficiary, such as a trust, charity, and one’s own estate, as well as the opportunities such planning creates.
Unless indicated, Traditional IRAs and Roth IRAs are referenced collectively as “IRAs” below. The available options for withdrawing from either one are basically the same.
As always, the following is an abridged version of the rules. The best option in your particular case will depend on your specific circumstances.
Withdrawal Options Available to the Individual Beneficiary
Upon inheriting the IRA account, a beneficiary can opt to immediately take his or her entire share out of the IRA. However, remember that as stated above, all money withdrawn from a Traditional IRA is subject to income tax treatment.
- Example: Jack inherits a $250,000 IRA account in 2011 and immediately withdraws it all. Jack must declare $250,000 of additional income on his 2011 tax return. He will pay the highest federal tax rates (currently 33 or 35%) on some, if not all, of the funds.
Rollover (surviving spouse only)
If named as sole beneficiary, the IRA owner’s surviving spouse can opt to rollover the IRA account into his or her own IRA account. This must be done within 60 days of the receipt of the funds.
This option is available only to a surviving spouse named as beneficiary. No other beneficiary can do this.
- Example: Jack is the surviving spouse and sole beneficiary of his wife’s IRA. Jack may rollover the funds into his own IRA.
The beneficiary can transfer the original owner’s IRA account into an “Inherited IRA” account held in the name of the original owner. The following options are available to the individual beneficiaries.
- First, if there is more than one named beneficiary, the inherited IRA can be split into separate accounts for each beneficiary by December 31 in the year following the original owner’s death. This is not a required step.
- Example: John passes away in October 2011, leaving his friends Jacob and Smokey as his IRA beneficiaries. Jacob and Smokey can either split John’s IRA into separate accounts by December 2012 or transfer all the assets into a “John’s Inherited IRA” account.
- If the original owner was under 70½ at death, the beneficiary has two choices:
- 5-Year Rule: Take any amounts as long as all the IRA’s assets are distributed by the end of the 5thyear after the original owner’s death.
- Example: From the John IRA example immediately above, Jacob and Smokey would have to pull out all IRA assets by December 2016 (and, of course, pay all applicable income taxes).
- Required Minimum Distribution: Take a minimum amount of money (called a “required minimum distribution” or “RMD”) from the account every December 31 for life, starting in the year following the original owner’s death.
- For separate Inherited IRAs, the RMD is based on the beneficiary’s life expectancy (as provided by the appropriate IRS Table).
- For Inherited IRAs with multiple beneficiaries, the RMD is based on the oldest beneficiary’s life expectancy.
- Example: From the John IRA example –
- If Jacob and Smokey had separate accounts, Jacob’s RMD is based on Jacob’s life expectancy and Smokey’s RMD is based on Smokey’s life expectancy.
- If the account wasn’t separated, the RMD would be based on the older person’s life expectancy.
- If the original owner was over 70½ at death, then the beneficiary or beneficiaries must use the RMD method.
The individual beneficiary can opt to refuse all or some of the IRA assets. Under the Internal Revenue Code § 2518(b)(2), a disclaimer is only “qualified” (i.e. acceptable) if it is:
- An irrevocable and unqualified refusal of the assets;
- Signed and in writing;
- Received by the original owner’s legal representative 9 months after the later of:
- The day the IRA assets were transferred to the beneficiary; or
- The day the beneficiary turns 21; and
- Not already accepted in any form by the beneficiary.
Additionally, be sure to take a look at your state’s law on disclaimers for any additional requirements as well.
Named Custodian / Property Guardian (minors only)
A minor child cannot inherit an IRA until the age of majority. Instead, a custodian must be named on behalf of the underage beneficiary.
- This person is usually named in the original owner’s will. Sometimes, financial institutions will even allow the minor to designate the custodian.
- However, the minor would then have the right to take all the assets by age 18 or 21 (depending on state law).
- This potential result is a strong motivation for naming one’s own trust or estate as the beneficiary of the IRA assets.
- This concept will be discussed in greater detail in the referenced future post on “entity beneficiaries”.
- Publication 590: Individual Retirement Arrangements (irs.gov)
- Traditional IRA Distribution Flowchart (keytlaw.com)
- Roth IRA Distribution Flowchart (keytlaw.com)
- Significant Assets Not Covered By Wills (lawprofessors.typepad.com)