January 3, 2018. By Lori Patterson:
IRA (Individual Retirement Account) owners have the option of listing one or more beneficiaries and the percentage of the assets they will leave to each heir. Depending on the relationship of the owner and the beneficiary of the assets, the heir will have different options available for receiving this type of inheritance. As such, the beneficiary may receive assets in the form of an inherited IRA and continue the tax-deferred growth as the beneficiary of the deceased owner. If this is the case, there will be stipulations on those assets when received as per Internal Revenue Service rules.
If the beneficiary of the IRA is the account owner’s spouse, he or she will have several options to consider. These include: liquidating the IRA and a receiving cash distribution, rolling the assets into his/her existing IRA, or transferring the funds to a separately titled Inherited IRA. The latter strategy is useful if the surviving spouse is older than 70½ and has already begun taking required distributions from another IRA and does not necessarily need the additional income (thus allowing the remaining assets more time to grow tax-deferred).
If the beneficiary chooses to transfer the funds to an Inherited IRA, the mandatory distributions may be delayed if the original owner had not reached the age of 70½. This last option also allows the surviving spouse to access the funds at any time without penalty making this option advantageous when the IRA owner and the beneficiary are both young.
A non-spouse beneficiary to an IRA also has the option to roll the assets into an inherited IRA. In this case, the beneficiary will move the assets to a separate retirement account and must take annual distributions based on his/her own life expectancy. Generally, the required distributions will need to begin during the year following the death of the original owner. Distributions are penalty-free regardless of age if they are taken each year by December 31st, or within five years of the original owner’s death when this option is allowable.
There are two options for the non-spouse beneficiary regarding required annual distributions: 1) the life-expectancy rule and 2) the five-year rule. With the life-expectancy rule, the beneficiary receives mandatory distributions over his/her lifetime and based on a uniform life expectancy table provided by the IRS. The five-year rule is allowable if the decedent had not yet begun the required distributions. In the case of the latter, the beneficiary has the option to skip the annual required distributions but must withdraw the inherited funds in-full within five years of the original owner’s death.
Important information to keep in mind for retirement accounts:
- When an IRA owner passes, take care to understand all your options as the beneficiary. If transferring funds, be sure to do so using the correct account titling to avoid unintended and costly tax consequences.
- In the case of multiple IRA beneficiaries, separate the assets for each beneficiary in order to manage required distributions specifically to the life expectancy of each individual.
- Pay close attention to the rules and deadlines for mandatory distributions to avoid penalties by the IRS. These can be hefty reaching 50% of the amount of the required distribution for the missed deadline.
- Consequential beneficiaries (i.e. those inheriting an Inherited IRA) may not have the option to delay distributions when the second owner passes. If the second deceased owner had begun taking the required distributions from the inherited IRA, then the beneficiary must continue taking them based on the same life expectancy of the decedent. This will likely deplete the retirement assets at a faster pace.
- Keep beneficiary designations up-to-date, especially after life events such as marriage, family additions, or divorce.
We understand that when paired with the accompanying emotions related to the loss of a loved one, navigating these types of inheritances can be challenging. Clients should never hesitate to call with any questions regarding the planning, management, titling, or transition of these accounts.