Some time back, I wrote a post called “On My Death, Please Take a Breath” about how one should wait before doing anything in haste financially after the passing of a loved one. I paid specific attention to the inheriting of an IRA, and received some feedback prompting a longer discussion.
First, there are different rules if you inherited the IRA from a spouse or non-spouse. If your spouse passed and left you an IRA, you are able to roll it into your own account, and treat it as your own.
If you inherited the IRA from a parent (for example) or other non-spouse, the rules are a bit tricky, but not impossible, to understand. The IRA becomes retitled as JoeTaxpayer, beneficiary, Charles Schwab Custodian. It’s most important to note, the funds can NOT be mingled with any other funds you have. You must begin taking withdrawals by December 31 of the year following the person’s death, and you use the life expectancy table 1 in Appendix C of IRS Publication 590 to determine your required distributions. Note also, you refer to this table once only, for the initial distribution. In subsequent years, you reduce the divisor by 1, unlike withdrawals from your own IRA after 70-1/2 where you refer to the table each year to find your new withdrawal requirement.
Another important point – If the original IRA had contingent beneficiaries, you may disclaim your inheritance and allow the next in line to inherit the IRA. Why would you do this? If you are a high earner, in a high tax bracket, you may not need the money at all, or if the next person listed as beneficiary is your child, their RMDs (required minimum distributions) may be so small, they avoid tax, or are minimally taxed.
While on the topic of contingent beneficiaries, an IRA must have its beneficiaries noted on the account, they are not inherited through a will. If there is no beneficiary listed on the account or if the only beneficiary either pre-deceases or dies along with the account owner, the IRA funds must be withdrawn by the heirs within five years of the passing of the owner. Note, in your will you can include instructions to your beneficiaries not to withdraw the funds in the IRA after your passing. This is the worst decision they can make. If they are afraid of the stock market, or don’t understand the investments you left them, they should simply change its contents to Treasury bonds or CDs.
Lastly, this is a complicated topic, it’s easy for even the so-called pros to make an error. Read up to understand the rules, and ask questions before you make a tragic mistake and are hit with a huge tax bill. A final note, I mention nothing about converting your inherited IRA to a Roth IRA. This is not allowed for a non-spouse beneficiary, and for a spouse, only if they put the IRA into their own name first.
September 17th, 2009 at 4:36 pm
Interesting post. It can be a nightmare for an average person to figure out the implications of an inherited IRA, especially if you have multiple non-spouse beneficiaries, such as children.
I like the motto of keep it simple… So I’d advise closing out/cashing out as soon as possible, assuming it makes financial sense to do so. Otherwise, precious life is wasted trying to figure out the IRS rules.
September 17th, 2009 at 5:44 pm
You may wish to re-read my Take a Breath article, cashing out is exactly the wrong thing to do…..
Joe
October 19th, 2009 at 11:06 am
Good article. I lived through this situation. My mother died and left an IRA for the children. Once the paperwork was completed, the IRA was split into 5 parts for the 5 children. Then each child was able to decide for themselves if they would cash out or whatever. I did take about 1/3 of it out to help cover estate expenses and some other things BUT I paid about 50% of that 1/3 in taxes. You will pay state and Federal taxes and need to check how much it is in your state. Some states are outrageous. Take the time to read up on this – become knowledgeable on the subject and don’t take advice from just one financial advisor – try many. With the advisors help, I was able to determine how much to take out without panicing due to the poor economy. Make sure you set aside at least 50% of the $ for tax and don’t forget about the yearly withdrawals. There are online charts to check for that amount.
October 19th, 2009 at 11:41 am
I’m sorry for your loss. It’s especially tough when there are no assets outside the pretax accounts to cover final expenses. Ideally, the beneficiaries are only subject to the small annual withdrawals.
December 28th, 2009 at 5:34 am
[...] Inheriting or Bequeathing an IRA explaining the rules to properly handle the details of the IRA before and after one passes [...]
January 2nd, 2011 at 5:06 pm
Thank you for your easy-to-comprehend advice! I’m new to the IRA bequeathing issue. I was shocked to learn how impossible it is to leave these accounts to my blood offspring. May I ask?
My living Father transferred to me, at this very late juncture in life, two investment accounts that he’d opened when I was a child. I’m now 60. I want to protect those accounts from inheritance by my husband or his family; and to preserve them for my own natural born grandsons. Clearly my husband has no vested interest in the accounts. I’ve learned that cannot name a Transfer On Death beneficiary without my husband’s sign-off and that just is not practical.
What can I do to most effectively and efficiently bequeath these accounts to my own blood offspring?
January 3rd, 2011 at 9:19 am
Is this an IRA you’re asking about? I don’t believe you need anyone’s permission to change your own beneficiary on these, is your broker saying otherwise?
January 4th, 2011 at 8:09 am
They are two investment accounts my Father started years ago. Their TOD forms have a section for the spouse to sign-off my beneficiary desgination if it’s anyone other than him. The forms read that this spousal sign-off is mandatory or, regardless of my designation, at my death the spouse inherits 50% anyway; and the remaining 50% is set-aside for that process.
From reading the firms’ TOD forms, I assumed these were IRAs or 401k(s). My Father has since said they are not “retirement” accounts, but they are personal investment accounts in stock market funds. There’s a bit of a process to name a new TOD and I want to be sure it’s done right.
Thanks for your reply!
January 4th, 2011 at 12:12 pm
No problem, good luck Karen. The only account I’ve ever seen that needs a spouse sign off is a pension, surprised that this has such a restriction.
February 12th, 2011 at 11:53 pm
[...] * JOE TAXPAYER provides a good overview of “Inheriting or Bequeathing an IRA”. [...]
October 24th, 2011 at 8:05 pm
I am facing this situation right now. Is it worth all the trouble (to do something other than a full payout) if the IRA is relatively small? I am talking about $77k split between 4 beneficiaries (all children of the deceased).
October 24th, 2011 at 8:17 pm
The effort is minimal, paperwork to the broker holding the IRA. Even $20K in the account can grow over time if the beneficiary only withdraws the required minimum each year. A shame to have it withdrawn and taxable all this year.
January 3rd, 2012 at 4:27 pm
Question: If my granddaughter is 12 in 2011…and she is the receipient of my IRA …how does she withdraw the required minimum distribution and how does she pay the taxes on the amount she withdraws. Can she be allowed to keep it in the original investment…until she needs it for college? She is too young to file a tax return….how does this work?
January 3rd, 2012 at 6:43 pm
Ok, first you look at publication 590 and see that at age 12, she has a divisor of 70.8. You then take the IRA balance at 2011 year end, say, it’s $100,000. 100000/70.8 = $1412.43. This is her RMD for 2012. She is not ‘too young’ to file a return, I think my child’s first return was when she was 2. Keep in mind, there is a kiddie tax exemption, so the child gets $950 with no tax at all, and the next $950 at 10%. In my example, about $46.
Yes, the parent can just add to their return, but that would be at their rate, not a good idea. Last, the withdrawal can be “in-kind” which means it can be made in the form of the stock or fund within the IRA. If it’s a stock, it’s OK to go over a bit, e.g. round up to the nearest whole share, and pay the small tax due. Remember the RMD is the minimum required, more is ok. Next year, you do not refer to the chart, her divisor goes down by one each year.
How you manage it once it’s out of the IRA is up to you, but one way is to set it aside in her name, and when she’s working, use it to help her fund a Roth IRA, but that’s another subject.
March 22nd, 2012 at 10:19 pm
what if you are over 57 when you inherit the ira do you still get taxed on the portion you inherit and withdraw?
March 22nd, 2012 at 11:02 pm
Yes, regardless of age, if the IRA is all pretax money, it’s all taxed at withdrawal. Of course, this is at one’s marginal rate, so a child may pay little to no tax at all, and if one is in a low bracket, they might stay in that bracket by just taking out the RMD (required minimum distribution)
April 12th, 2012 at 8:21 pm
My Mom passed away in December 2011. Her wishes in her Will were for her assets to be divided equally between myself and my 2 sisters. At some point my Mom listed me as beneficiary of her traditional IRA. The custodian has refused to abide by the instructions in the Will as the beneficiary form supersedes the Will. This is in the state of Tennessee. Is there a way to get the balance of the IRA divided 3 ways without cashing it in for a lump sum payout. We all would like to stretch out the payout. If I choose to disclaim a portion of the balance would it go to my Mom’s estate and enable my other 2 sisters to receive their portion? The tax attorney says to talk to the CPA, and the CPA says to talk to the tax attorney….The amount is around $170,000, so the taxes would be substantial on a payout. Any guidance would be appreciated.
April 12th, 2012 at 8:44 pm
If you are the listed beneficiary, and there is no other, by disclaiming the money, it would revert to her estate. The five year rule then applies, all funds must be depleted within 5 years after the owner’s passing. I can’t say whether the custodian will permit a partial disclaiming.
If it were me – I’d take the RMDs each year, pay the tax, and gift the siblings their “share.” You can view Pub 590 to see your RMD, but for example, at 50, the divisor to use is 34.2, so 170,000/34.2 is $4971. You can withdraw more if you wish, but be mindful of where you are in your marginal rate.
For legal purposes, you owe the siblings nothing, and the will’s executor would give you one third of the estate ignoring the IRA money. This should serve as a warning for any reader who has beneficiaries listed on their IRA, but has a different split in their will.
I hope this helps.
April 12th, 2012 at 8:53 pm
If I disclaim the entire amount and the money is moved to the estate, would I still be eligible to receive my 1/3 of the funds? Also how would the withdrawals be handled? Would we still set up the “inherited IRA’s” accounts? Some of the reading that I have done danced around the answer to that question, sounding like if I disclaimed it, I would not be entitled to any funds from the IRA.
April 12th, 2012 at 9:26 pm
When you inherit an IRA through proper beneficiary forms on file, you keep the titling as “JoeTaxpayer Sr, Deceased, for benefit of JoeTaxpayer Junior.” Once it’s inherited otherwise, through a will, the stretch option is broken, and the five year rule kicks in.
All my reference material explains the right way to have set up the beneficiaries pre-passing, or the actions post-passing either with or without the beneficiary forms. I find nothing that would spell out a plan to address your combination of events and goal. That said, I’d spend time with the custodian of the IRA, and try to better understand what the custodian believes the options are. Since you are in control, propose to the custodian that the IRA in your mom’s name still, is split 3 ways into 3 accounts, beneficiary form in tact. Then disclaim the inheritance on two of the three accounts. They may refuse this, but I believe it passes proper procedure.
By the way, the five year rule isn’t so bad. Divided by 3, the $170K is just under $57K each, and by taking just over $11K per year, the taxes would be minimized. If you are not using a 401(k) and IRA to the maximum deposits each year and have earned income, you can just increase deposits to absorb some of this money each year.
April 12th, 2012 at 9:41 pm
Thank you so much for your time. I will contact the custodian so we can discuss the options. I enjoy your website.
April 12th, 2012 at 9:49 pm
Thanks for your kind words! The tax code is complex, but I actually enjoy keeping up with it and helping people. The topic of IRAs and inherited IRAs is particularly tough, easily stumping the experts. Let us know how the custodian responds to all this. Be well.
April 16th, 2012 at 10:40 am
I want to disclaim my 50% share of my widowed mother’s IRA and have my half go to my 2 children (my sister is the other 50% beneficiary). Rather then wait until after my mother passes to disclaim my interest, can I just have my mother now sign an updated IRA beneficiary form stating my 2 children as the primary beneficiaries of my 50% interest?
April 16th, 2012 at 10:49 am
Jeff – Thank you for writing in. To be clear – Disclaiming your share at your mom’s death would give all of it to your sister as it stands now. So, yes, absolutely, approach mom and ask her to update the beneficiaries form, 50% sis, 25% child 1, 25% child 2. After mom passes, there would still be the matter of properly splitting the IRA into 3 accounts. If you are helping her with her money, I suggest doing this now, 50/25/25, and use the RMDs each year to even out the account balances if they are invested differently.
As far as I’m concerned, each transaction is a chance for a mistake to break the IRA. Doing this in advance will help avoid future mistakes. Each account should have contingent beneficiaries as well. Let me know if this fully addressed your concerns.
April 16th, 2012 at 2:23 pm
Thank you for your help.
April 17th, 2012 at 7:26 pm
Could you explain some of the complications of leaving an IRA to a spouse and children. I understand you would still split the IRA into separate accounts but are there any other complications? This is a second marriage and my husband would like to leave some to me and some to his children. He was also thinking of grandchildren who are minors.
If part of the IRA is left to grandchildren there would have to be custodians correct? Could the custodians withdrawal the money lump sum for the grandchildren without restriction?
April 17th, 2012 at 10:32 pm
The one thing about the spouse as beneficiary which is unique (to spouse only) is that the spouse can re-title into her own name, and if she in under 70-1/2, no RMDs are due. When leaving an IRA to any non-spouse, the beneficiary must be sure the custodian titles the account properly – “JoeTaxpayer IRA (deceased 1/1/2010) F/B/O JoeTaxpayer Jr, Beneficiary.” In this case, if Joe Jr simply retitles to his own name, the IRA is broken and the five year rule kicks in, the ability to stretch RMDs over his life is lost.
Thinking the Will is how an IRA is inherited is one of the other issues. It’s important the IRA itself reflect the chain of beneficiaries desired. If the IRA has no beneficiary designation or the beneficiaries have predeceased the owner, the IRA passes via the Will and Estate, and again, the lifetime RMD opportunity is lost, 5 year rule kicks in. Other issues come into play when the beneficiary is an ex-spouse the deceased forgot to remove from the forms. I hope this helped.
For your husband’s IRA – I suggest he first split the IRA into at least two accounts. One account to reflect the amount he wishes to leave you. If you have no heirs, he can put his kids as contingent beneficiaries. (When creating the chain of beneficiaries, it’s important to consider the chance, however slim, that people can perish in the same accident.) For the other funds, he can split as he wishes, but I’d be sure he includes contingent beneficiaries on that account as well. A child’s IRA has to have a guardian/custodian. Yes, funds can be withdrawn “for the benefit of the child.” If I ran a brokerage firm, I’d offer a free choice – An account with a low expense index fund, and RMDs automatically disbursed, but no additional funds regardless of circumstance. There are ways of doing just this via a trust, but this can get pretty expensive both to set up and maintain each year if a third party is used as trustee.