What Happens When the Estate Inherits an IRA?
By Beverly DeVeny, IRA Technical Expert
Follow Me on Twitter: @BevIRAEdSlott
We frequently see situations where the estate is the IRA beneficiary either because the beneficiary form was never completed, has been lost by the IRA custodian, or, worst of all, the account owner actually named the estate as the beneficiary of the IRA.
What options do you have when the estate inherits the IRA? If someone tells you the IRA must be cashed out, which is a fully taxable distribution, don’t fall for it. Occasionally an IRA agreement may give a beneficiary no other option. But you want someone to show you where it says that in the IRA agreement. Don’t just take their word for it.
The tax code allows for two distribution options. They depend on the age of the account owner at his (or her) death. When death occurs before April 1st of the year after the account owner turned 70 ½ (this is called the required beginning date or RBD), the IRA must be paid out by the end of the fifth year after death – the 5-year rule. You have no required distributions each year; you just have to make sure the account is empty by the end of the fifth year.
Example: Kate was 70 on March 13, 2012. She died on September 13, 2012, the day she turned 70 ½. But she died before April 1, 2013, which is her RBD. If her estate inherits her IRA, the IRA will have to pay out by 12/31/2018, the end of the fifth year after her death.
In the second option, death occurs after the RBD.
Here Kate died on September 13, 2013. Now distributions to the estate can be made using the balance of Kate’s life expectancy. Kate turned 71 in the year of her death. The life expectancy factor (from the IRS Single Life Table) is 16.3. When the estate calculates its first required distribution (RMD) it will use a factor of 15.3. You subtract one from the previous year’s factor each year to get the factor for the current year.
Does the estate have to remain open for the next 15.3 years in order to receive the annual RMDs? IRS says no, it does not. When the estate inherits, a properly titled inherited IRA is set up for the estate. Example: John Smith, deceased, IRA fbo (for benefit of) J. Smith Estate
When the estate is closed, the executor or personal representative of the estate informs the IRA custodian that the shares for each beneficiary of the estate should be assigned to inherited IRAs in their names. A direct transfer of inherited IRA assets is done to an inherited IRA fbo each estate beneficiary. This does not change how the RMDs are calculated. The beneficiaries must continue to use the balance of Kate’s life expectancy. Now the estate can be closed.