[IMGCAP(1)]Many Individual Retirement Account holders die without having consumed the account balances; therefore, beneficiaries will be entitled to the balance.
These distributions are reportable as ordinary income. Also, the account’s value is part of the decedent’s gross estate, making these IRAs subject to income and estate taxes upon death.
Here are some of the rules and options available to IRA beneficiaries:
A surviving spouse can rollover the deceased’s account to his or her own IRA. Often, a surviving spouse will elect this option to defer income taxes. A spouse can opt for a partial distribution rolling over the account balance into his or her own IRA.
Non-spouse beneficiaries, such as children, cannot roll over the decedent’s IRA. If the decedent was taking required minimum distributions, then the non-spouse beneficiary can: (1) take a lump sum distribution; (2) set up an “inherited” IRA and take required minimum distributions based upon his or her own age; or (3) continue taking the required minimum distributions based upon the decedent’s age.
Although the RMD rules do not apply to Roth IRAs during the accountholder’s lifetime, they do apply to after-death distributions.
If the decedent died prior to the RMDs requirement age, the non-spouse beneficiary has a fourth option. The IRA could be distributed to the beneficiary within five years.
A Non-Spouse Beneficiary Hypothetical
Let’s assume Bill died at age 72, owning an IRA valued at $1 million. He named his two adult children, Sam and Diane, as beneficiaries. What options do they have? What are the tax results?
1. They can each elect a lump sum distribution. Each would report $500,000 as income and pay an income tax based on their marginal income tax rates.
However, in the event Bill had an estate subject to estate tax, the estate tax attributed to the IRA would be deductible.
2. In lieu of lump sum distributions, they would have up until the year after death on December 31 to set up one or two separate “inherited” or “stretch” IRAs. That year, and each thereafter, they would have to take a minimum distribution based upon their ages and the account’s value at the end of the prior year.
3. They could continue taking IRA distributions based on Bill’s age, as though he survived. This option usually doesn’t make sense since the beneficiary could always take a distribution greater than the minimal amount.
Now, let’s suppose that Bill died prior to reaching the RMDs requirement age of 70 ½. Besides the above options, a beneficiary has a five-year deferral option. Bill’s IRA beneficiaries could take partial distributions over the five-year period, or wait until the period is up and take a lump sum account payment. However, if the beneficiary wants to utilize the stretch option, he or she must make an election by December 31 of the year following death.
In estates where estate tax liability is due, whether or not the beneficiary may want to elect a stretch option may depend on whether there are other assets to pay the tax.
Ernie Guerriero, CLU, ChFC, CEBS, CPCU, CPC, CMS, AIF, is director and head of qualified plan marketing for the Business Resource Center for Advanced Markets at The Guardian Life Insurance Company of America, where he oversees the qualified plan department that provides sales, marketing, and technical support on qualified retirement plans.
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