Some time back, I wrote a post called “On My Death, Please Take a Breath” about how one should wait before doing anything in haste financially after the passing of a loved one. I paid specific attention to the inheriting of an IRA, and received some feedback prompting a longer discussion.
First, there are different rules if you inherited the IRA from a spouse or non-spouse. If your spouse passed and left you an IRA, you are able to roll it into your own account, and treat it as your own.
If you inherited the IRA from a parent (for example) or other non-spouse, the rules are a bit tricky, but not impossible, to understand. The IRA becomes retitled as JoeTaxpayer, beneficiary, Charles Schwab Custodian. It’s most important to note, the funds can NOT be mingled with any other funds you have. You must begin taking withdrawals by December 31 of the year following the person’s death, and you use the life expectancy table 1 in Appendix C of IRS Publication 590 to determine your required distributions. Note also, you refer to this table once only, for the initial distribution. In subsequent years, you reduce the divisor by 1, unlike withdrawals from your own IRA after 70-1/2 where you refer to the table each year to find your new withdrawal requirement.
Another important point – If the original IRA had contingent beneficiaries, you may disclaim your inheritance and allow the next in line to inherit the IRA. Why would you do this? If you are a high earner, in a high tax bracket, you may not need the money at all, or if the next person listed as beneficiary is your child, their RMDs (required minimum distributions) may be so small, they avoid tax, or are minimally taxed.
While on the topic of contingent beneficiaries, an IRA must have its beneficiaries noted on the account, they are not inherited through a will. If there is no beneficiary listed on the account or if the only beneficiary either pre-deceases or dies along with the account owner, the IRA funds must be withdrawn by the heirs within five years of the passing of the owner. Note, in your will you can include instructions to your beneficiaries not to withdraw the funds (i.e. not to ‘cash out’ the account 100%, but only take RMDs, this is a note you’d include, it’s not binding) in the IRA after your passing. This is the worst decision they can make. If they are afraid of the stock market, or don’t understand the investments you left them, they should simply change its contents to Treasury bonds or CDs.
Lastly, this is a complicated topic, it’s easy for even the so-called pros to make an error. Read up to understand the rules, and ask questions before you make a tragic mistake and are hit with a huge tax bill. A final note, I mention nothing about converting your inherited IRA to a Roth IRA. This is not allowed for a non-spouse beneficiary, and for a spouse, only if they put the IRA into their own name first.
Interesting post. It can be a nightmare for an average person to figure out the implications of an inherited IRA, especially if you have multiple non-spouse beneficiaries, such as children.
I like the motto of keep it simple… So I’d advise closing out/cashing out as soon as possible, assuming it makes financial sense to do so. Otherwise, precious life is wasted trying to figure out the IRS rules.
You may wish to re-read my Take a Breath article, cashing out is exactly the wrong thing to do…..
Joe
Good article. I lived through this situation. My mother died and left an IRA for the children. Once the paperwork was completed, the IRA was split into 5 parts for the 5 children. Then each child was able to decide for themselves if they would cash out or whatever. I did take about 1/3 of it out to help cover estate expenses and some other things BUT I paid about 50% of that 1/3 in taxes. You will pay state and Federal taxes and need to check how much it is in your state. Some states are outrageous. Take the time to read up on this – become knowledgeable on the subject and don’t take advice from just one financial advisor – try many. With the advisors help, I was able to determine how much to take out without panicing due to the poor economy. Make sure you set aside at least 50% of the $ for tax and don’t forget about the yearly withdrawals. There are online charts to check for that amount.
I’m sorry for your loss. It’s especially tough when there are no assets outside the pretax accounts to cover final expenses. Ideally, the beneficiaries are only subject to the small annual withdrawals.
Thank you for your easy-to-comprehend advice! I’m new to the IRA bequeathing issue. I was shocked to learn how impossible it is to leave these accounts to my blood offspring. May I ask?
My living Father transferred to me, at this very late juncture in life, two investment accounts that he’d opened when I was a child. I’m now 60. I want to protect those accounts from inheritance by my husband or his family; and to preserve them for my own natural born grandsons. Clearly my husband has no vested interest in the accounts. I’ve learned that cannot name a Transfer On Death beneficiary without my husband’s sign-off and that just is not practical.
What can I do to most effectively and efficiently bequeath these accounts to my own blood offspring?
Is this an IRA you’re asking about? I don’t believe you need anyone’s permission to change your own beneficiary on these, is your broker saying otherwise?
They are two investment accounts my Father started years ago. Their TOD forms have a section for the spouse to sign-off my beneficiary desgination if it’s anyone other than him. The forms read that this spousal sign-off is mandatory or, regardless of my designation, at my death the spouse inherits 50% anyway; and the remaining 50% is set-aside for that process.
From reading the firms’ TOD forms, I assumed these were IRAs or 401k(s). My Father has since said they are not “retirement” accounts, but they are personal investment accounts in stock market funds. There’s a bit of a process to name a new TOD and I want to be sure it’s done right.
Thanks for your reply!
No problem, good luck Karen. The only account I’ve ever seen that needs a spouse sign off is a pension, surprised that this has such a restriction.
The effort is minimal, paperwork to the broker holding the IRA. Even $20K in the account can grow over time if the beneficiary only withdraws the required minimum each year. A shame to have it withdrawn and taxable all this year.
I am facing this situation right now. Is it worth all the trouble (to do something other than a full payout) if the IRA is relatively small? I am talking about $77k split between 4 beneficiaries (all children of the deceased).
Question: If my granddaughter is 12 in 2011…and she is the receipient of my IRA …how does she withdraw the required minimum distribution and how does she pay the taxes on the amount she withdraws. Can she be allowed to keep it in the original investment…until she needs it for college? She is too young to file a tax return….how does this work?
Ok, first you look at publication 590 and see that at age 12, she has a divisor of 70.8. You then take the IRA balance at 2011 year end, say, it’s $100,000. 100000/70.8 = $1412.43. This is her RMD for 2012. She is not ‘too young’ to file a return, I think my child’s first return was when she was 2. Keep in mind, there is a kiddie tax exemption, so the child gets $950 with no tax at all, and the next $950 at 10%. In my example, about $46.
Yes, the parent can just add to their return, but that would be at their rate, not a good idea. Last, the withdrawal can be “in-kind” which means it can be made in the form of the stock or fund within the IRA. If it’s a stock, it’s OK to go over a bit, e.g. round up to the nearest whole share, and pay the small tax due. Remember the RMD is the minimum required, more is ok. Next year, you do not refer to the chart, her divisor goes down by one each year.
How you manage it once it’s out of the IRA is up to you, but one way is to set it aside in her name, and when she’s working, use it to help her fund a Roth IRA, but that’s another subject.
Yes, regardless of age, if the IRA is all pretax money, it’s all taxed at withdrawal. Of course, this is at one’s marginal rate, so a child may pay little to no tax at all, and if one is in a low bracket, they might stay in that bracket by just taking out the RMD (required minimum distribution)
what if you are over 57 when you inherit the ira do you still get taxed on the portion you inherit and withdraw?
If you are the listed beneficiary, and there is no other, by disclaiming the money, it would revert to her estate. The five year rule then applies, all funds must be depleted within 5 years after the owner’s passing. I can’t say whether the custodian will permit a partial disclaiming.
If it were me – I’d take the RMDs each year, pay the tax, and gift the siblings their “share.” You can view Pub 590 to see your RMD, but for example, at 50, the divisor to use is 34.2, so 170,000/34.2 is $4971. You can withdraw more if you wish, but be mindful of where you are in your marginal rate.
For legal purposes, you owe the siblings nothing, and the will’s executor would give you one third of the estate ignoring the IRA money. This should serve as a warning for any reader who has beneficiaries listed on their IRA, but has a different split in their will.
I hope this helps.
If I disclaim the entire amount and the money is moved to the estate, would I still be eligible to receive my 1/3 of the funds? Also how would the withdrawals be handled? Would we still set up the “inherited IRA’s” accounts? Some of the reading that I have done danced around the answer to that question, sounding like if I disclaimed it, I would not be entitled to any funds from the IRA.
When you inherit an IRA through proper beneficiary forms on file, you keep the titling as “JoeTaxpayer Sr, Deceased, for benefit of JoeTaxpayer Junior.” Once it’s inherited otherwise, through a will, the stretch option is broken, and the five year rule kicks in.
All my reference material explains the right way to have set up the beneficiaries pre-passing, or the actions post-passing either with or without the beneficiary forms. I find nothing that would spell out a plan to address your combination of events and goal. That said, I’d spend time with the custodian of the IRA, and try to better understand what the custodian believes the options are. Since you are in control, propose to the custodian that the IRA in your mom’s name still, is split 3 ways into 3 accounts, beneficiary form in tact. Then disclaim the inheritance on two of the three accounts. They may refuse this, but I believe it passes proper procedure.
By the way, the five year rule isn’t so bad. Divided by 3, the $170K is just under $57K each, and by taking just over $11K per year, the taxes would be minimized. If you are not using a 401(k) and IRA to the maximum deposits each year and have earned income, you can just increase deposits to absorb some of this money each year.
Thanks for your kind words! The tax code is complex, but I actually enjoy keeping up with it and helping people. The topic of IRAs and inherited IRAs is particularly tough, easily stumping the experts. Let us know how the custodian responds to all this. Be well.
My Mom passed away in December 2011. Her wishes in her Will were for her assets to be divided equally between myself and my 2 sisters. At some point my Mom listed me as beneficiary of her traditional IRA. The custodian has refused to abide by the instructions in the Will as the beneficiary form supersedes the Will. This is in the state of Tennessee. Is there a way to get the balance of the IRA divided 3 ways without cashing it in for a lump sum payout. We all would like to stretch out the payout. If I choose to disclaim a portion of the balance would it go to my Mom’s estate and enable my other 2 sisters to receive their portion? The tax attorney says to talk to the CPA, and the CPA says to talk to the tax attorney….The amount is around $170,000, so the taxes would be substantial on a payout. Any guidance would be appreciated.
Thank you so much for your time. I will contact the custodian so we can discuss the options. I enjoy your website.
I want to disclaim my 50% share of my widowed mother’s IRA and have my half go to my 2 children (my sister is the other 50% beneficiary). Rather then wait until after my mother passes to disclaim my interest, can I just have my mother now sign an updated IRA beneficiary form stating my 2 children as the primary beneficiaries of my 50% interest?
Jeff – Thank you for writing in. To be clear – Disclaiming your share at your mom’s death would give all of it to your sister as it stands now. So, yes, absolutely, approach mom and ask her to update the beneficiaries form, 50% sis, 25% child 1, 25% child 2. After mom passes, there would still be the matter of properly splitting the IRA into 3 accounts. If you are helping her with her money, I suggest doing this now, 50/25/25, and use the RMDs each year to even out the account balances if they are invested differently.
As far as I’m concerned, each transaction is a chance for a mistake to break the IRA. Doing this in advance will help avoid future mistakes. Each account should have contingent beneficiaries as well. Let me know if this fully addressed your concerns.
Thank you for your help.
Could you explain some of the complications of leaving an IRA to a spouse and children. I understand you would still split the IRA into separate accounts but are there any other complications? This is a second marriage and my husband would like to leave some to me and some to his children. He was also thinking of grandchildren who are minors.
If part of the IRA is left to grandchildren there would have to be custodians correct? Could the custodians withdrawal the money lump sum for the grandchildren without restriction?
The one thing about the spouse as beneficiary which is unique (to spouse only) is that the spouse can re-title into her own name, and if she in under 70-1/2, no RMDs are due. When leaving an IRA to any non-spouse, the beneficiary must be sure the custodian titles the account properly – “JoeTaxpayer IRA (deceased 1/1/2010) F/B/O JoeTaxpayer Jr, Beneficiary.” In this case, if Joe Jr simply retitles to his own name, the IRA is broken and the five year rule kicks in, the ability to stretch RMDs over his life is lost.
Thinking the Will is how an IRA is inherited is one of the other issues. It’s important the IRA itself reflect the chain of beneficiaries desired. If the IRA has no beneficiary designation or the beneficiaries have predeceased the owner, the IRA passes via the Will and Estate, and again, the lifetime RMD opportunity is lost, 5 year rule kicks in. Other issues come into play when the beneficiary is an ex-spouse the deceased forgot to remove from the forms. I hope this helped.
For your husband’s IRA – I suggest he first split the IRA into at least two accounts. One account to reflect the amount he wishes to leave you. If you have no heirs, he can put his kids as contingent beneficiaries. (When creating the chain of beneficiaries, it’s important to consider the chance, however slim, that people can perish in the same accident.) For the other funds, he can split as he wishes, but I’d be sure he includes contingent beneficiaries on that account as well. A child’s IRA has to have a guardian/custodian. Yes, funds can be withdrawn “for the benefit of the child.” If I ran a brokerage firm, I’d offer a free choice – An account with a low expense index fund, and RMDs automatically disbursed, but no additional funds regardless of circumstance. There are ways of doing just this via a trust, but this can get pretty expensive both to set up and maintain each year if a third party is used as trustee.
My mother passed away in April of 2002. In her IRA she named me and my brother as beneficiaries. I have yet to take possession of the IRA. I have spoken to the Custodian and they ask me if she was taking minimum withdrawls and asked me to contact the IRS to find out, since I don’t know if she did or not. I believe, they should have that in their records and just let me know. So, what are the consequences to have not taken possession within five years of her passing?
If done properly, you should have taken RMDs each year as beneficiary. There is a 50% penalty for RMDs not taken. Publication 590 shows the RMD requirements in Table 1. If you are in your 40’s it’s less than 3% per year, so to catch up, you need to do the math, and request a waiver of penalty, or pay 50% of the withdrawn amount.
You didn’t have to withdraw the account in 5 years, you should have been able to take RMDs the rest of your life.
Hi Joe,
My mother passed away last month, leaving about $270K in a rollover IRA. She was 68, so I don’t think she had started taking distributions, but I’m not sure. She had other assets, but the IRA was the largest asset by far. I have two sisters, but only one sister and myself were named as beneficiaries of the IRA. Her will stated that her assets be divided as follows:
25% to each daughter
Remaining 25% divided between 7 (minor) grandchildren
I am one of the co-executors of the estate, along with the sister who was NOT a beneficiary. The three of us agree that the IRA money should be divided according to our mother’s wishes in her will. We were going to do this by taking a lump sum and then gifting the appropriate amount to our sister and all the grandchildren. That would be a big tax hit for the two of us who are beneficiaries, and it doesn’t seem like the best route. Would maybe disclaiming a portion of the IRA be a better way to go? I don’t know if there are any contingent beneficiaries.
Many thanks for your help!
First, I am sorry for your loss.
It’s tough to try to ‘fix’ things after the fact. First, and most important, you need to find out if the IRA had contingent beneficiaries listed. If so, and if the broker is ok with partial disclaimers, you might get closer to your goal.
If not, IRAs that are inherited via will instead of named beneficiaries do not enjoy the opportunity for lifetime payouts. The payout (withdrawal) has to occur within 5 years. So this would mitigate the tax hit. If both listed beneficiaries disclaimed, and let the will take over, 3 daughters each get $67,500, and by taking $13K or so per year, the taxes won’t be so bad. The 7 grandkids each get less than $10K, so $2K per year.
Alternately, the two proper beneficiaries can take the IRA, properly split it, and title it as a beneficiary IRA, and take the new RMDs over her lifetime. They can both deal with this small withdrawal and share it each year with those they feel should have inherited the money. The required distribution in one’s 40s is just over 2% of the IRA’s value, so less than $6,000 from the account to divide.
This is a tough situation, one message I try to get out there is that 401(k), Pensions, and IRAs all pass outside of the will. A beneficiary can go to the broker with proper ID and the death certificate and the funds will be accessible. The will executor(s) do not need to be notified at all. So an estranged child or former spouse, aware of such an account can take what was originally due to them regardless of any present will.
Dear Joe, very informative article and responses to queries – thank you! One other query, my brother and I are named as beneficiaries in our now deceased Mother’s IRA (all pretax contributions) from which she as receiving RMD. Would the 15% early withdrawal penalty (in addition to ordinary income tax for Federal and State) purposes apply if we elect the cash out method (vs transfer to inherited IRA)? Also, the IRA was established in NYS and we live in CT, so I believe the applicable state tax is the residency state of the benediciary and not the domicile and residency (as well as earnings) state of the decedent – correct? Many thanks, Kay
Sorry for your loss, Kay.
The 10% early withdrawal penalty does not apply to inherited IRAs. I understand that you don’t want to take withdrawals over your lifetime, but I’d still suggest looking at your tax return to understand your marginal rate. It may make sense to split the withdrawals over a few years to avoid being pushed into a higher bracket. Last, I believe this lands only on a CT return, there’s no reporting back to NY.
Thank you !!
Joe, My father recently passed away and left his IRA to my brother and I to split. My brother is trying to take it all out to pay student loans and is wondering if this is not taxable for that reason or even if the taxes would be lower? I also have debts to pay off and would like to take out what i can to pay off my car note without paying more in taxes than i would in interest on the loan? Ive been reading up as much as i can but all the legal terminoligy gets mind boggling after a while. Would a tax professional from H&R Block be able to help me or should i just get it over with and cash out? Any advice would be much appreciated
Thank you!
I’m sorry for your loss.
Assuming the money was in a Traditional IRA and not a Roth, it’s all taxable when withdrawn. As a beneficiary, there is no age requirement to avoid penalty. You both just have tax due at your marginal rate. Depending on the amount in question, I suggest you look at your income, the near last line of the 1040, taxable income. If you are nearing the top of the bracket you are in, it may make sense to split the withdrawal over a year or two. If you you are paying off some high interest debt, I have no objection to this plan, I’d just hate to see you take the full withdrawal this year, when a split into 2013 might keep you I your current bracket both years. I will edit my response to link to my article at Rothmania.net whe I discuss marginal rates. Happy to answer a follow on question if this still isn’t clear.
Hi Joe:
Thanks for the great article. Two questions:
1. In one paragraph you noted that a beneficiary who inherits an IRA from a non-spouse must take the RMD’s.
2. In another paragraph you noted that a will can include instructions to your beneficiaries not to withdraw the funds in the IRA after your passing
These to statements seem to be conflicting. Please advise…thank you
Hi Laurie, I edited just now to try to clarify. The note in the will is to be used to explain the RMD process to the beneficiary, and suggest they not pull withdrawal the entire account balance and avoid the error made by the man in the article On My Death, Please Take a Breath. The beneficiary has the option to take what he wishes each year, the RMD is a minimum, not maximum. The note in the will is just a suggestion, enforcement takes a more complex process involving a trust.
My sister passed 1 1/2 ago and has left my mother with 2 IRA’s both are list my mother as the benefiary. She passed suddently and unexpectantly and had no valid will that we were able to locate, therefore, leaving my nephew Ryan (her only son) as the beneficary to the estate……We were able to obtain the first IRA in my mother’s name without any problem, however, we seem to be getting the complete and utter run around with cashing in the 2nd thru Matthews Asia IRA company……we have jumped thru and submitted all of the requested paperwork but they still are wanting an original form of the Tennessee Inheritance Tax Closing Letter. This is where we are running into the road block, because her son being the executor has fallen off the face of the Earth and cannot be tracked down to obtain this form thru, the probate lawyer that her son used/went thru …….retired and left no forwarding information. So can you suggest where we go next? We have already spoken with the Tennessee Department of Revenue and they told us that we need to either go thru her son or patician the court to become executor, but in order to do this we would have to travel to Tennesssee! Please Help! Thank you!
I’m sorry for your loss. When something is outside of my expertise, I’ll be quick to admit it.
I know a lot about IRAs and how to title them for inheritance. When done wrong, or not at all, they are subject to probate as is any asset of the estate. I’m not familiar with the rules and details of probate, only how to avoid it, as it creates a headache as you’ve discovered. Sorry I couldn’t be of more help to you.
One quick question if you don’t mind. I am the executor of my uncle’s estate,(uncle Jesse) It was going to be real simple till I got a call from an executor of my other uncle’s estate. (uncle Buford). Uncle Buford had list as beneificiary on an IRA Uncle Jesse. Uncle Buford passed away 1st. and I found out about this the week after Uncle Jesse passed away. So what do I need to do, the Bank says that I need a letter of testimentary to verify that I am the executor. (I had power of attorney prior to my uncles passing and I am listed in the will as the executor why should I have to petition the court for this letter? Anyway they say they need the letter and copy of the death cert. then they will release the IRA to the estate. The will states that myself and my cousin are to share equal portions of all monies left in any accounts. Is this the best way to handle this and let the estate pay the taxes on the IRA. since my deceased uncle was 91 yrs old. Thanks
Re: retirement insurance annuity beneficiary changed-help needed
Since 2000, I was listed as the sole beneficiary on blood relative annunity.
Lady buddies up to him and 5 moths later he dies from cancer of liver while she is caring for him. I open envelope to follow his wishes, and call annuity company to learn my name was replaced 11 days prior with help from a 3rd party who also had my relative write a will same day to give the home, etc also to lady. She took care of relative for 2 whole days and he gave her almost 1 million seems highly unlikely! He became very ill those 2 days. Doc says they were waiting for my call while she told folks she was not calling me and she did not call until he was comatose. She had all my numbers and emails. I also learn 4 mos prior relative adds this same lady’s name to policy again with the help of this 3rd party who was just being nice. That time they left my name. I filed disputed day of finding which is also day of death. I also sent yesterday medical reports showing man was very ill the day he is suppose to have signed papers and will! He was falling all over room, I’ve in arm, disoriented, very out of it mentally. I am not sure of next step? Will they contact me? The ins com implied that the change of bene was not complete so then I think it would revert back to me, right? Relative also wrote will that day saying all accts at annuity bank go to this caretaker. coincidence she was kick out of her mothers trust for 1mil in jan 2012 and started working my relative in April 2012. Thoughts suggestions?…..thank you.
My wife is in the process of rolling over an inherited IRA that she was the beneficiary for from her father. Is there any way that she can turn it into a Stretch IRA for our kids instead of herself?
Joe, Thank you for your article and info. My mother died on Oct. 11 of this year at age 90, leaving my brother and me co-beneficiaries of an IRA of $13,000. I have not brought the death certificate to the custodian/ bank yet because I want to be sure I handle this the best way. The bank is scheduled to send her annual minimum distribution in early December. Question 1: Can I simply wait to present the death certificate, allow the check to come in her name, deposit into her checking account and include it as income on her 2011 tax returns? The bank rep I spoke with the other day said this was OK, but is this legal/ kosher?
Question 2: Since the IRA is a relatively small amount, my brother & I are not interested in maintaining inherited IRA accounts. The IRA is in a CD earning 4.25% that matures in March 2013. Can I just present the death certificate to the bank at that time, and divide and cash it out then? We understand it will be taxed as regular income on our 2012 tax returns. Thank you for any help with this!
If the kids were listed as contingent beneficiaries, she can disclaim her share and let it go to them. If they weren’t on the IRA beneficiary form, the opportunity for them to inherit and stretch isn’t available.
I am so sorry to read this situation. This is a legal matter, not a tax issue. I’d be out of my league to try to give advice on this issue.
If a required distribution was due this year, it should be taken out in your uncle’s name. Whatever is left should be distributed to you and the cousin. You would pay the tax on the amount you withdraw each year. You can either take withdrawals over your uncles life expectancy if he was taking RMDs or over 5 years to keep the taxes low.
1 – yes the RMD for 2011 is taken in 2012 as income on her return.
2 – for such a small amount, I agree, just cash it out when the CD matures. The bank should first split the funds in half, putting the money in beneficiary IRAs in each of your names and then let you withdraw under your own social security numbers.
I am sorry for your loss.
My Mom, who recently passed and was over the age of 70-1/2, had a traditional IRA naming myself and 2 siblings as beneficiaries. I understand we have to take the minimum distribution, but after that, can we take out more money for her expenses before it is split between the 3 of us?
My Mom passed in April 2012. I am the executor of the will. I have three siblings (so 4 total). One IRA with a bank had all 4 of us as beneficiaries, so that was easy. I just discovered 3 other IRAs with a different bank. Here’s the issues.
One IRA account has the beneficiary as my dad (who is deceased). I assume I can close that with my probate papers as it would go to the estate.
One has two siblings name on it, while another account has just one sibling’s name on it.
The siblings with their names as beneficiaries want the IRA’s to be split 4 ways. Is there a way the named beneficiaries can have these treated as if all 4 siblings were named? (ie can they add names?) Or is the only option cashing them out, paying the taxes and distributing the money that way?
Thanks