Inherited IRA's

IRA’s and Death of the Account Holder:


The ability to minimize taxes that need to be paid on the death of an IRA holder is a difficult area of the law and requires the advice of a professional as you will only do it once or twice, each time will be different and the results will be different because so many factors are involved. This blog is meant for informational purposes only and you should consult the advice of your advisor when you are named a beneficiary of an IRA holder who passes away.

In a traditional IRA, any money taken out is fully taxable as ordinary income, because it was a deduction when it was put in and any gains in the amount have never been taxed. Accordingly many people think that they must take all of the IRA that is left to them and pay taxes on that amount in the year that they take it, i.e., a lump sum distribution.

In 2007 the law changed and there is greater flexibility in how you can take the money out of an inherited IRA or an employer-provided retirement plan.

The first thing to be aware of is a couple of terms: Designation Date and Required Minimum Distribution. Designation Date is September 30 in the year following the year in which the deceased IRA holder died. It is the date by when the type of the distribution, lump sum, extended distribution time, five year distribution or roll over must be designated. The Required Minimum Distribution is the amount that the Federal government requires to be distributed from an IRA each year. Once the owner of an IRA reaches the age of 70 ½ the government requires that a minimum amount must be taken out each year and that amount is determined by a math formula which calculates that amount on the basis that if the RMD is taken out each year then when the account owner dies all of the money will have been taken out.

The first thing to do is to make sure that the deceased IRA owner had taken out his RMD for the year of his death, for if he hasn’t there is a 50% penalty. By the Designation Date the beneficiaries need to decide how they will take their distributions.

A surviving spouse can elect to roll the IRA into her/his own IRA; take the funds over 5 years or take the distribution of the funds over the life expectancy of the surviving spouse.

A non spouse beneficiary (who is qualified) can take over 5 years or over the beneficiary’s life expectancy. If the beneficiary is not qualified (not a natural person) then the distribution must be taken over the 5 year period if owner was younger than 70 ½ or the life expectancy of the deceased IRA owner if the owner was over 70 ½. If there are multiple beneficiaries then multiple accounts must be set up.