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Plan Well, Retire Well

Saving and investing your money

Inheriting an IRA When You Lose a Loved One


If there was one thing that I thought I understood thoroughly about managing someone's affairs after death, it was IRAs. I've taught about the rules for taking distributions – including taking distributions as a beneficiary – for years. But I was surprised by a couple of things about father's IRA after he died. There is a difference between knowing the rules and going through the process in real life.

Here's what I knew from writing Rules for Taking Distributions from Tax-Deferred Retirement Plans:

An IRA owner must begin taking required minimum distributions (RMDs) by April 1 of the year after he reaches age 70 ½, which is known as the required beginning date (RBD).

When a beneficiary inherits an IRA, the beneficiary usually must start taking distributions by the year following the year of death. If the deceased had not yet reached his required beginning date (RBD), the beneficiary's RMD is based on his own life expectancy. If the deceased had reached RBD, the beneficiary's RMD is based on the longer of the beneficiary's life expectancy or the deceased's remaining life expectancy. (Yes, under IRS rules, dead people have life expectancies!)

If the deceased had not yet taken his RMD for the year of death, that distribution must be paid out before distributions are made to beneficiaries.

When more than one beneficiary is named, the account can be split into separate accounts for each beneficiary.

If a spouse inherits an IRA, they have options that are not available to other beneficiaries. A spouse can treat the IRA as her own, name new beneficiaries, and use their own age to determine whether distributions are required – just as if they were the original owner of the account. If the spouse leaves the account in the name of a deceased who was not yet age 70 ½, the spouse can delay taking distributions until the deceased would have reached his RBD.

A beneficiary can do a direct transfer of the inherited IRA account to a new financial institution. The titling of the new account has to remain the same, so if I rolled over my father's IRA, it would still be in his name with my sister and I named as beneficiaries.

You can always take more than the RMD, but if you take less you'll pay a 50% penalty tax.

When my sister and I obtained the forms to fill out for Dad's IRA, there were a number of options offered for taking distributions – but rolling the account over to a different financial institution wasn't one of them. I asked questions of the bank and learned my New Fact #1: you can't roll over the account until the original account has already been changed to a beneficiary IRA, with the beneficiary choosing how they will take distributions.

There was also no place to instruct the bank to divide the IRA into separate accounts, based on the number of beneficiaries. According to the bank representative, the bank would automatically do that. Do all financial institutions do this? I don't know. And as you'll learn later, I didn't have a chance to see whether it would have happened here.

There was no place on the form to indicate that my father's RMD for the year of death still needed to be taken. Although I knew this rule, I'd never thought who made it happen or who received it. According to the bank's representative, that payment would automatically be made and it would be sent to the beneficiaries of the IRA. So that was New Fact #2.

The form listed ten ways of handling the account. Most fit with what I knew about distribution rules:

  • A lump sum (remember, you can always take more than the RMD).
  • A spouse treating the account as his or her own
  • Spouse's option to delay distributions until the deceased would have reached age 70 ½.
  • Life expectancy payouts based on 1) the beneficiary if the deceased had not reached RBD, or 2) the greater of the deceased's remaining life expectancy or the beneficiary's life expectancy, if the deceased has reached his RBD.
  • Five-year payout for accounts whose owners who died before their RBD.

I was somewhat confused by the other options. They were each listed twice, once for a deceased who had reached his RBD and again for a deceased who had not:

  • Annual payments of an amount specified by the beneficiary.
  • Payments over a number of years specified by the beneficiary.

IRS rules don't require or even mention these distribution options. I assume they are provided as an easy way for beneficiaries to understand the distributions and know exactly how much or for how long they'll receive them. The concept of distributions over a life expectancy is a little more complicated. But what if you choose an amount or number of years that has you taking out less than the RMD? Is someone at the bank monitoring these elections and running the numbers - not just when the election is made but EACH YEAR to make sure that you aren't going to be hit with 50% penalties on RMD amounts that you failed to take? While these look like useful, easy-to-understand choices, I think there is some risk in using them.

My sister and I completed these forms, only to be informed by the bank a few weeks later that we were not named as beneficiaries on the account. So I can't tell you how things would have proceeded from there.

In cases like this, the plan documents usually determine who receives the money. The bank's letter explained that the funds would be paid to either a named beneficiary, a surviving spouse, or to Dad's estate. There is no named beneficiary and Mom died before Dad, so his estate becomes the heir. In the end, my sister and I will still receive the money, but it will have to go through probate. We will be required to take the distributions over the remainder of Dad's life expectancy rather than our own, longer life expectancies. And it's extra work for the executor, who must provide evidence of her authority and manage the process.

Have you ever inherited an IRA? How does this compare with your own experience? Please leave a comment below and tell us about it.



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COMMENTS



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Great post, Karen - the real-life vs. "by-the-book" contrasts can be huge. I just rewatched the webinar you and B. O'Neill did two years ago (one of the BEST webinars ever, truly.) I remember really appreciating it at the time, but apparently I didn't download the 10-page fact sheet referenced in the webinar: Rules for Taking Distributions from Tax Deferred Retirement Plans. I tried following that link now, but it didn't work. I did get here, though, which is great! My question: is that fact sheet still current and available somewhere? Or would you be willing to share it with me even if it's not officially posted somewhere? Barb
by Barb Wollan on Sunday 7/21/2013

Thanks to Barb for pointing out that Rules for Taking Distributions from Tax-Deferred Retirement Plans wasn't posted online anymore. We've taken care of that, and you can access the revised 2013 version at http://web.extension.illinois.edu/cfiv/downloads/49483.pdf
by Karen Chan on Tuesday 8/6/2013