Question:  “My husband died earlier this year and had a large amount of money in his Individual Retirement Account (IRA). I understand from our Financial Advisor that I need to make some decisions about this IRA. Would you please share with me some of the decisions that need to be made when it applies to my inheriting his IRA account, including the time frame for making these decisions and what the tax consequences of making certain decisions may be?”

Answer:  First, you did not indicate your husband’s age when he passed but we will infer he had been taking Required Minimum Distributions (“RMDs”) from his IRA account annually.  For a given IRA account holder, once RMDs are required, withdrawals must be taken each and every subsequent year.  A given year’s RMD is based on the account balance as of December 31 of the previous year.  Families sometimes forget that means a RMD is required for the year in which the death occurs, with the withdrawal made in the year following the year of death.  A RMD will need to be taken out of his IRA by December 31, 2013.

Second, it is crucial that you obtain a copy of the beneficiary designation on file with the financial institution where the IRA account is held.  An IRA account holder can modify their beneficiary designation as often as they like while they are alive.  But once the account holder dies, the last submitted designation will govern what can happen with the account.  The ideal scenario from an estate planning perspective is for a beneficiary designation to include not only a primary beneficiary, but also one or more secondary beneficiaries.  Depending on the financial circumstances of you and other family members, and what sort of estate planning you and your husband may have engaged in, it might make for the primary beneficiary to “disclaim” the account, thereby letting the account pass to one of the secondary beneficiaries.

That is done via a formal legal document called a “disclaimer.”  A disclaimer can be thought of as a sort of legal no thank you, simply requesting that the financial institution treat the signing beneficiary as if they too are deceased, thereby permitting the account to pass to the next successive beneficiary.  While a well-drafted beneficiary designation may appear to the layman to be unnecessarily cumbersome, the intention to provide the IRA account holder’s family maximum flexibility.

Please bear in mind the following:

1)      If a disclaimer is to be filed, it must be submitted to the account holding financial institution within nine (9) months of the date of death.  So, you will want to obtain copy of the designation as soon as possible in order to allow plenty of time for you to consult with your elder law attorney, your accountant, and/or other pertinent family members.

2)      A key legal element to a disclaimer is that the disclaimant cannot take possession or otherwise control or benefit from the asset to be disclaimed.  In other words, if the financial institution sends you a check from the IRA account, do not cash the check before you consult with your advisors.

Third, as the surviving spouse of an IRA account holder, you get to choose one of two distinctly different ways in which the account will pass to you.  You can elect for the account to be treated as an “inherited” IRA, which largely means you will continue to take annual RMDs based on your life expectancy starting the year of death.  In contrast, you could instead elect to “roll over” the IRA.  When that is done, the tax rules essentially treat the account as if it was yours from the beginning.

Why would you want to do that?  This allows you to defer taking any distributions until you reach 70 1/2.  Of course in some circumstances, you may want to simply liquidate the account.  Since the tax bill will be the largest when all the money is withdrawn from the IRA at once in a given year, it is unsurprising the IRS will readily allow you to do that!  In order to avoid taxed when rolling over his IRA into your own, the amount withdrawn from the initial account must be deposited into your own account within sixty (60) days of the withdrawal.  To avoid the possibility of immediate taxation we generally recommend an IRA to IRA transfer.

Fourth, the ability to “stretch out” IRA distributions over a longer period of time is frequently advocated by tax planners, especially in scenarios when the surviving spouse and/or other heirs have sufficient assets outside the IRA.  However, whether or not IRA distributions can be stretched out over a long period of time, will depend in part whether the account has a “Designated Beneficiary.”  That is a term of art used in the tax code and a complete discussion of the topic is beyond the scope of a brief response to your question, but suffice it to say if some part of the IRA can potentially pass to a charity, a limited liability company, or a probate estate, the entire IRA will therefore not have a Designated Beneficiary.

The presence of any one of these “problem” beneficiaries will mean the entire account must be withdrawn within five (5) years of the date of death of the original account holder.  Imposition of the 5 year rule will likely result in an increased income tax liability on the withdrawals.  However, if problematic beneficiaries can be removed by September 30 following the year of death, then the 5 year rule may be avoided.  The easiest way to do that is to completely withdraw and distribute the portion of the IRA that would go to a problem beneficiary, leaving the remainder to remain in the account for the beneficiaries who do not pose a problem.  Then, the IRA can then be considered to have a “Designated Beneficiary” and a stretch out of withdrawals is still possible.

When the IRA beneficiary is to be a trust, much care and attention must be paid to drafting and administering the trust and the IRA.  If done properly, a trust as an IRA beneficiary may be split into separate trust shares for individual beneficiaries, in a manner where each respective individual trust beneficiary’s life expectancy will apply to RMDs.  If that is the case, separate IRA accounts for each respective trust beneficiary must be established by December 31 of the year following the year of death.

In summary, planning for the appropriate distribution of IRAs so that you get the best income tax results and financial results for beneficiaries is a complex undertaking that in many cases is not properly addressed.

Weatherby & Associates, PC
Bloomfield, Connecticut

Decisions About Inheriting an IRA account was last modified: November 14th, 2022 by Henry Weatherby