8.14 Inherited Traditional IRAs
Although inheritances are generally tax free (11.4), distributions that you receive as a beneficiary of a traditional IRA are taxable. However, if the account owner made nondeductible contributions to the account, distributions allocable to those contributions on Form 8606 are tax free under the rules at 8.9. Taxable distributions received as a beneficiary are not subject to the 10% penalty for distributions received before age 59½ (8.12).
Surviving spouses. A surviving spouse who is the sole beneficiary of a deceased spouse’s IRA may elect to treat the account as his or her own IRA or roll it over (60-day rollover after receiving distribution) to his or her own IRA. By becoming the IRA owner, the surviving spouse determines his or her required minimum distributions (RMDs) under the regular owner rules (8.13), rather than under the beneficiary rules discussed in this section.
Caution
Nonspouse beneficiaries. A nonspouse beneficiary may not elect to be treated as the owner or make a rollover. However, the IRS allows a nonspouse beneficiary to make a trustee-to-trustee transfer of the IRA to another financial institution as long as the IRA into which the funds are moved is set up and maintained in the name of the deceased IRA owner for the benefit of the nonspouse beneficiary. Whether or not the account is transferred, a nonspouse beneficiary must receive required minimum distributions (RMDs) under the beneficiary rules below. The financial institution holding the account will change the Social Security number on the account from the deceased owner’s number to the number of the beneficiary for purposes of tracking RMDs. However, a nonspouse beneficiary must make sure that the deceased owner’s name remains on the account. Putting the account in the nonspouse beneficiary’s name would be treated by the IRS as a prohibited rollover, resulting in a taxable distribution, as if the beneficiary had received a total distribution of his or her share of the IRA. For example, if Jane Smith dies on March 4, 2013 and her brother John is her IRA beneficiary, the account should indicate that the IRA is held for the benefit of (FBO) John as beneficiary, with wording such as this: “Jane Smith, deceased March 4, 2013, IRA FBO John Smith, Beneficiary.”
Caution
Beneficiaries must receive required minimum distributions (RMDs).
Beneficiaries of a traditional IRA must receive a required minimum distribution (RMD) from the inherited account for each year after the year of the IRA owner’s death. This includes a surviving spouse who elects to receive distributions from an inherited traditional IRA as a beneficiary rather than treating the IRA as her or his own.
If you are the “designated beneficiary” as determined under the final IRS regulations discussed below, RMDs may be spread over your life expectancy (see Table 8-5). You must receive the first RMD by the end of the year following the year of the IRA owner’s death. The RMD for each subsequent year must be received by December 31 of that year. If the RMD for a year is not received, you are subject to a penalty tax of 50% on the difference between the required minimum amount and the amount actually received. Of course, you are not limited to the RMD. You may withdraw more than the annual RMD amount or even withdraw your entire interest in the account should you want the funds. Keep in mind that whatever you receive will be taxable except to the extent that it is allocable to nondeductible contributions made by the deceased account owner.
Who Is the Designated Beneficiary?
The maximum life expectancy period over which required minimum distributions (RMDs) may be extended generally depends on the identity of the “designated beneficiary” as of September 30 of the year following the year of the owner’s death. Any individual who is a beneficiary as of the date of the owner’s death can be a “designated” beneficiary, whether he or she is selected as beneficiary by the IRA owner or is selected under the terms of the plan, but for purposes of determining the maximum period over which RMDs can be paid, there can be only one “designated beneficiary” for each inherited traditional IRA.
Under the final IRS regulations, the determination of the designated beneficiary is not made until September 30 of the year following the year of the IRA owner’s death. However, despite the September 30 rule, an exception allows multiple individual beneficiaries to separate their accounts and use their individual life expectancies to figure their RMDs, provided the separate accounts are established by December 31 of the year following the year of the owner’s death; see the discussion of the separate account rule below.
A beneficiary named through an estate, either under the owner’s will or by state law, cannot be a designated beneficiary for RMD purposes. An estate or a charity cannot be a designated beneficiary. Trust beneficiaries may qualify if certain tests are met, as discussed below.
The delay in determining the designated beneficiary does not mean that new beneficiaries can be added after the owner’s death. However, after the account owner’s death and prior to the September 30 determination date, a beneficiary named as of the date of death can be eliminated by means of the beneficiary’s qualified disclaimer or distribution of the beneficiary’s benefit. A beneficiary’s interest can be cashed out by the September 30 determination date, leaving the balance to other co-beneficiaries named by the owner. For example, if a charity and an individual are named as co-beneficiaries, and the charity’s interest is cashed out by the September 30 determination date, the remaining beneficiary can use his or her life expectancy to figure RMDs.
Qualified disclaimer.
A qualified written disclaimer made no later than nine months after the IRA owner’s death can be used by an older primary beneficiary to pass all or part of an IRA to a younger contingent beneficiary. The disclaimer, made by the September 30 determination date, leaves the younger beneficiary as the designated beneficiary, thereby allowing required minimum distributions to be spread out over his or her longer life expectancy. Of course, a younger primary beneficiary may also disclaim in favor of an older contingent beneficiary. An estate may not disclaim its interest in order to create a designated beneficiary.
One of the requirements for a qualified disclaimer is that the person making the disclaimer must not have accepted the property prior to the disclaimer. The IRS in Revenue Ruling 2005-36 held that this rule does not prevent a beneficiary from making a disclaimer after taking the RMD for the year of the death (where the owner dies before receiving it). The act of taking the RMD is treated as an acceptance of that portion of the property, plus the income attributable to the distribution. However, after receiving the RMD, the beneficiary may make a qualified disclaimer (by the nine-month deadline) of all or part of the balance of the account, except for the income allocable to the RMD. The disclaimed amount and the income allocable to the disclaimed amount must either be paid outright to the successor beneficiary entitled to receive it following the disclaimer or be segregated in a separate IRA for the benefit of that beneficiary. See Revenue Ruling 2005-36 for further details.
Multiple individual beneficiaries can split IRA into separate accounts.
If a traditional IRA has several beneficiaries as of the September 30 determination date, all of whom are individuals, the general rule under the regulations is that the oldest beneficiary with the shortest life expectancy is considered to be the designated beneficiary, and that life expectancy is the period over which all the beneficiaries must receive required minimum distributions (RMDs). This result can be avoided by splitting the IRA into separate IRAs, one for each beneficiary. Each beneficiary can then spread distributions over his or her individual life expectancy.
If the IRA account owner did not split the account into separate IRAs, the regulations allow the beneficiaries to do so by December 31 of the year after the year of the owner’s death. If the account is split in the year following the year of the owner’s death by the December 31 date, each beneficiary may compute the RMD for that year using his or her own life expectancy as determined by their ages in that year. That life expectancy is reduced by one year for each subsequent-year RMD.
Individual and non-individual beneficiary for same account.
If as of the September 30 determination date there is a non-individual beneficiary other than a qualifying trust, as well as one or more individual beneficiaries, the owner is treated as not having a designated beneficiary. If the owner’s death was on or after his or her required beginning date (April 1 of the year after the year age 70½ is reached), the regulations require RMDs to be made over the owner’s remaining life expectancy. Use the owner’s life expectancy as of his or her birthday in the year of death and reduce it by one year for each subsequent year. For example, assume an 80-year-old IRA owner received his RMD for 2012 in mid-2012 and then died later in the year, leaving the IRA to his estate. The owner’s life expectancy in 2012 was 10.2 years (Table 8-5 life expectancy for 80-year old), and that would be reduced by one, to 9.2 years, to figure the RMD for 2013. If the account balance at the end of 2012 was $200,000, the RMD for 2013 would be $21,739 ($200,000 ÷ 9.2).
If the owner died before the required beginning date without a designated beneficiary, the entire account must be distributed by the end of the fifth year following the year of death. No distribution has to be received before that fifth year. If the interest of the non-individual beneficiary is distributed from the plan and separate accounts are established for the individual beneficiaries by the September 30 deadline, the individual beneficiaries can base required minimum distributions on their own life expectancies.
Trust as beneficiary.
If a trust is named the beneficiary of the account, the trust beneficiaries may be treated as designated beneficiaries if certain tests are met. The trust must be irrevocable or become irrevocable upon the account owner’s death. Documentation of the trust beneficiaries must be provided to the IRA trustee or plan administrator. The deadline under the regulations for providing the documentation is October 31 of the year following the year of the owner’s death. However, the regulations do not allow separate accounts to be created for the trust beneficiaries. All of the trust beneficiaries must receive RMDs over the life expectancy of the oldest beneficiary.
Beneficiary’s death before September 30 determination date.
If an individual named as a beneficiary by the account owner dies after the owner but before the September 30 date for determining the designated beneficiary, that individual continues to be treated as a designated beneficiary under the final regulations. This means that the remaining life expectancy of the deceased beneficiary must be used by his or her successor beneficiary, whether that successor was named by the original beneficiary or under the terms of the original beneficiary’s estate.
Did IRA Owner Die Before His/Her Required Beginning Date or On or After the Required Beginning Date?
The distribution period for beneficiaries may depend on whether the IRA owner died before his or her required beginning date, or on or after the required beginning date, which is April 1 of the year that the owner reached or would have reached age 70½ (8.13).
Owner’s death on or after required beginning date.
If an owner dies on or after the required beginning date (April 1 of the year after the year the owner reaches age 70½), and there is a designated beneficiary, required minimum distributions (RMDs) are generally payable over the beneficiary’s life expectancy. However, if on the date of the owner’s death the designated beneficiary is older than the owner, the final regulations allow the beneficiary to receive RMDs over the owner’s remaining life expectancy rather than over the beneficiary’s shorter life expectancy. If there is no “designated” beneficiary, as when the owner’s estate is named as the beneficiary, RMDs are based upon the deceased owner’s remaining life expectancy.
If the owner did not receive his or her RMD for the year of death, the beneficiary must receive that amount in the year of death or as soon as possible in the next year.
The first RMD to a designated beneficiary must be received in the year following the year of the owner’s death. The RMD is figured by dividing the year-end account balance for the year of death by the designated beneficiary’s life expectancy in the year following the year of death, taken from the Beneficiary’s Single Life Expectancy Table (Table 8-5).
To figure the RMDs for later years, the designated beneficiary reduces his or her initial life expectancy by one for each succeeding year. The Example at the beginning of 8.14 (Todd and Fred Taxpayer) illustrates how the computation is made.
Successor beneficiaries. If the designated beneficiary dies before receiving the balance of the inherited IRA, the successor beneficiary may not start a new RMD schedule based upon his or own life expectancy. The successor must use the remaining life expectancy of the designated beneficiary. For example, assume a 47-year-old designated beneficiary figures his first RMD (for the year after the year of the IRA owner’s death) using his initial life expectancy of 37 years (Table 8-5 for 47-year-old), and he dies after receiving two more RMDs. The successor beneficiary “steps into the shoes” of the designated beneficiary and continues to reduce the designated beneficiary’s life expectancy each year just as the designated beneficiary would have. Thus, the successor beneficiary would use a remaining life expectancy of 34 years to figure his or her first RMD and would continue to reduce it by one each year until the IRA is completely distributed or the declining life expectancy is used up.
Owner’s death before required beginning date.
If an owner dies before the required beginning date and there is an individual designated beneficiary, the period for receiving required minimum distributions (RMDs) is generally the life expectancy of the designated beneficiary. The computation of required minimum distributions under the life expectancy method is explained above under “Owner’s death on or after required beginning date.” The life expectancy method is the “default” rule under the final regulations, but the plan may require application of the five-year rule, although this is unlikely, or the plan may allow the account owner or beneficiary to elect the five-year rule.
Under the five-year rule, the entire account must be distributed by the end of the fifth year after the year of the owner’s death; no distribution is required for any year prior to that fifth year. The five-year rule always applies if the owner dies before the required beginning date and there is no designated beneficiary.
Special Rules for Surviving Spouses
A surviving spouse may take advantage of rules not available to nonspouse beneficiaries.
Surviving spouse’s rollover or election to treat IRA as his or her own.
A surviving spouse who is the sole beneficiary of an IRA with unlimited withdrawal rights may elect to treat the IRA as his or her own by retitling the IRA in his or her name. If the surviving spouse contributes to the IRA or does not receive a timely RMD under the beneficiary rules, the surviving spouse is deemed to have made the election. The final regulations confirm that to make the election, the surviving spouse must take the RMD for the year of the owner’s death (if any) to the extent that it was not received by the owner.
A surviving-spouse beneficiary may also make a spousal rollover by authorizing a direct transfer (trustee-to-trustee) of the IRA, or rolling over a distribution within 60 days of receiving it, to his or her own IRA. However, if the deceased IRA owner did not receive the RMD for the year of death, the surviving spouse must receive and pay tax on that RMD; that amount cannot be rolled over (or directly transferred).
If the surviving spouse elects to treat the inherited IRA as his or her own or makes a spousal rollover, the surviving spouse is then subject to the same rules as any IRA owner. The surviving spouse should immediately name a new beneficiary for the IRA. The regular distribution rules apply, including the 10% penalty for taxable distributions received before age 59½ (8.8). If the surviving spouse is under age 70½, RMDs may be delayed until April 1 of the year following the year in which he or she reaches age 70½, at which time distributions will be based on the Uniform Lifetime Table for owners (8.13).
Surviving spouse as sole beneficiary.
If the surviving spouse does not elect to treat an inherited IRA as his or her own, and does not make a spousal rollover, the surviving spouse must receive required minimum distributions (RMDs) as a beneficiary. A surviving spouse who is under age 59½ and needs the funds from the IRA may prefer this option because withdrawals, although taxable (unless allocable to nondeductible contributions made by the deceased spouse), are not subject to the 10% penalty for pre-59½ distributions (8.12).
Planning Reminder
If the surviving spouse is the sole designated beneficiary, RMDs are based on his or her life expectancy from the Beneficiary’s Single Life Expectancy Table (Table 8-5). Each year, life expectancy is recalculated using the spouse’s attained age during the year. A spousal beneficiary is the only beneficiary who may recalculate life expectancy. Others must reduce their life expectancy from Table 8-5 for the year after the year of the owner’s death by one year in each succeeding year.
If a surviving spouse is the sole designated beneficiary and the deceased spouse died before the year in which he or she would have reached age 70½, the surviving spouse does not have to begin receiving RMDs until the year that the deceased spouse would have reached age 70½.
Even if a surviving spouse begins receiving RMDs under the beneficiary rules, the surviving spouse may at any time make a spousal rollover to his or her own IRA, excluding the RMD for the year, which must be received and reported as income as it is not eligible for rollover.