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5-Year Rule, Beneficiary, decedent, Distribution Rules, Early Withdrawal Penalty, Estate as Beneficiary, Executor, Inherited IRA, Inherited Traditional IRA, IRA Owner, Required Beginning Date, Required Minimum Distribution, Traditional IRA
When a traditional IRA owner dies, it’s not unusual for an executor to realize that the estate is the beneficiary of the inherited traditional IRA. Whether the traditional IRA owner forgot to complete the beneficiary form, forgot to replace a deceased beneficiary on the beneficiary form, or purposely named the estate as a beneficiary, the executor must handle the inherited traditional IRA for the estate. Unfortunately, most common executors, when the estate is the beneficiary, will assume that the only option to close the IRA account is to take a lump-sum distribution. This results in higher taxes on the distribution, and the estate beneficiaries lose years of growth opportunity for the account. Regardless, what many common executors don’t know is that there are other options in handling the inherited traditional IRA when the beneficiary is the estate.
Basic Rules for the Inherited Traditional IRA
Regardless of the beneficiary associated with the inherited traditional IRA, the IRS established three common rules concerning the inherited traditional IRA:
- The inherited traditional IRA requires distribution to eventually close out the account.
- Any distributions taken are taxable.
- The 10% early withdrawal penalty does not apply.
Since the inherited traditional IRA requires distribution, the IRS established distribution rules based on the age of the IRA owner at death.
Distribution Rules for the Inherited IRA with the Estate as Beneficiary
The executor has three options available to handle the inherited traditional IRA when the estate is the beneficiary. First, to help decide the distribution option, the IRS established a few guidelines:
- The IRS allows the executor to open an inherited IRA in the name of the decedent for the benefit of the estate. This will allow the executor to manage distributions by transferring the assets from the inherited traditional IRA to the inherited IRA in the name of the estate.
- April 1st of the year following the year in which you reach 70 ½ is the Required Beginning Date (RBD). The RBD is the date the IRA owner must begin taking required minimum distributions.
- The required minimum distribution (RMD) is a calculation using the IRA balance and dividing it by the life expectancy factor of the IRA owner. The annual calculation determines the amount of RMD the IRA owner must take for each year beyond the RBD. This process continues until the IRA account has a zero balance.
Distribution Rule if IRA owner was under 70 1/2 at Death
The estate can delay distributions until December 31st of the fifth year anniversary of the owner’s death. At this point, all assets must be distributed or penalties will result. The IRS calls this the 5-year rule.
Distribution Rule if IRA owner was 70 1/2 or Older at Death
The estate must take RMD’s beginning by December 31st of the year after death using the decedent’s remaining single life expectancy to determine the RMD. A couple of notes related to this distribution rule:
- If the owner of the IRA died before taking the RMD for the year, the estate must take the RMD for that current year.
- If the decedent reached the age of 70 1/2 but died before April 1st of the following year, no minimum distribution is required because the death occurred before the RBD. The RMD’s must begin the following year and received before April 1st of the next year.
Take a Lump-Sum Distribution
The executor may transfer the assets into an inherited IRA and distribute all the assets at once. The estate will pay taxes on the entire taxable portion of the distribution.
Executor Considerations
Before an executor decides which option to take in managing the distributions, the executor must consider the following:
- The distribution rules using the RBD require managing the inherited IRA for 5 years or more. In a formal probate proceeding, the estate usually closes in a year. Does the executor want to accrue more administrative expenses by extending probate to manage the inherited IRA? Does the executor want to manage the inherited IRA and the estate for five or more years? The answer is … not likely. In this instance, the IRS will allow the executor to establish an inherited IRA in the decedent’s name for the benefit of the estate beneficiaries after closing the estate. This will result in a direct transfer from the inherited IRA for the estate to the inherited IRA for the beneficiary. However, the problem with this rule is that many custodians of IRA’s pay distributions according to the IRA agreement. If the IRA agreement spells out that distributions go to the estate when the estate is the beneficiary, then the only option for the executor is to take the lump sum distribution. Otherwise, the executor will have to shop for a custodian that will allow inherited IRA’s for the benefit of the estate beneficiaries.
- The executor should consider the number of beneficiaries in the estate. If there are many beneficiaries due to inherit in the estate, the executor will have a hard time finding a custodian to open an inherited IRA for each beneficiary.
So, while considering the next move, the executor also needs to consider the IRA agreement and the amount of beneficiaries in the estate.
Conclusion
Since distributions taken by the estate are taxable to the estate, the executor will have to file an estate income tax return. Perhaps the best choice in handling distributions from an inherited IRA with the estate as the beneficiary is to choose the lump-sum distribution. Although taking a lump-sum distribution is not ideal, the deductions allowed in the estate income tax return may reduce the tax bite. Furthermore, the executor can have a smooth close to the administration by closing out the inherited IRA rather than finding ways to pass the inherited IRA to the estate beneficiaries. Conversely, the simple solution is for the estate planner, during life, to designate beneficiaries to all types of retirement accounts and don’t name the estate as beneficiary. This would eliminate a lot of headaches for their executor.
References
Since inherited IRA distributions are income to the estate, refer to the article Estate Income Tax Rates and your Estate Plan to learn the effects on your estate plan.
IRS Publication 590-B, Distributions from Individual Retirement Arrangements (IRA’s).
For a more in-depth look at the distribution rules for inherited IRA’s regarding all types of beneficiaries, refer to the article provided by Charles Schwab, Inherited IRA Rules | Traditional and Roth IRA Withdrawal.
Is my description of the distribution rules confusing? Was this article helpful to you? Share your comments or questions in the comment box below.
When a traditional IRA or Qualified Plan balance is transferred as a lump sum to an Estate, taxes are withheld by the IRA / Plan administrator. If the gross distributions must be reported on Form 1041 as income to the estate, what happens to the tax withheld? Does the Estate request its refund on Form 1041? I do not see anything suggesting it is passed through to the beneficiaries. Is this correct?
Thanks so much!
Hi Myrl,
This question should be asked to a tax professional because Form 1041 has elections an executor must make. In my experience, when my CPA was filing the 1041, he asked me if I wanted to pass the estate income to the beneficiaries to take advantage of their lower tax rates. I agreed to pass the income to the beneficiaries through k-1’s along with their share of the amount of tax withheld from the IRA administrator. This is where the 1041 is above my head and why I used a professional to deal with the 1041. If an executor elects to have the estate pay taxes, I assume the amount of witholdings are used as deductions on the 1041 when calculating the tax? I am not sure. What I can tell you is that the estate tax rates are the same as personal tax rates except with estate income, you reach the highest rate around $13,000.00. In my administration, the amount of income was well above the $13,000.00 threshold. So, I had to elect to pass through the income to lower the overall tax of the estate.
I hope this helps, but I had to use professionals for this topic. I did provide links at the bottom of the article that may be of some additional help.
Good luck,
Robert
If there is an executor who is also part of the estate going to receive 50% of the proceeds of the Ira and then there are 2 other parties that will each get 25%. The executor wants to keep the money over years but the 2 that are getting 25% want the lump sum right away. We are only talking about say a 300k total ira. Can the executor take the 150k for the 2 parties and give them 75k and then the executor does what they want with theirs or does it have to be the same for everyone?
Hi Billy,
If the beneficiaries are listed on the IRA, then all you have to do is give them the account number, a copy of the death certificate, and the institution that holds the IRA. Then, the beneficiaries can claim their portion of the IRA. However, if the beneficiaries were not listed on the IRA, then as executor you can take the lump sum for the two other beneficiaries and give them the money. In this case, the IRA would have to go through probate and you may have to wait to distribute until the final accounting is completed.
I hope this helps.
Robert
I am the PR for a large estate. There are several named beneficiaries, with the residual of the estate going to a specific single 501c3 charity. The IRA named Estate as beneficiary. There is enough “other” liquidity in the Estate to distribute cash to named beneficiaries of the Will, with the IRA value being the “residual” to go to named charity. Questions:
A) If IRA administrator will allow, can I as PR name the single charity as the beneficiary of IRA, to ease in transfer of the IRA funds to the charity? It seems from research, IRS allows the beneficiary designation, but can the PR decide which beneficiary, as long as I am complying with the Will, as to disbursements?
B) If estate is forced to take a lump sum, and I push out income via K-1, can I as PR allocate that specific income to the charity, without allocating any to other beneficiaries?
As PR, do I have authority to allocate the Estate assets in that way, as long as beneficiaries are receiving what the Will stated they were to receive?
Hi Kristie,
Since the IRA has the estate as the beneficiary, the IRA has to be probated and distributed as determined by the will. The intent of the decedent is to distribute the proceeds of the IRA to the beneficiaries of the will. It seems the charity is a residuary beneficiary, which means the charity will receive whatever is left after paying taxes, bills, expenses of the estate, and distributions to listed beneficiaries. So, if it were me as the PR, I would ask each beneficiary if they were willing to give up their piece of the IRA and distribute the proceeds to the charity. Otherwise, you can face a contest from the beneficiaries.
So, what will happen is that the IRA administrator will move the money into the Inherited IRA they will create. If you still want to list the charity as the beneficiary, this is where you would list the charity on the Inherited IRA. The administrator of the IRA should ask you for one beneficiary to list on the Inherited IRA. Myself, I wouldn’t do this. Instead, I would take the lump sum after the Inherited IRA is set, then distribute according to the will. There are other ways to distribute an Inherited IRA that would be less taxing, but you would have to manage the Inherited IRA for up to 10 years.
Finally, it seems to me that distributing the IRA to only the charity goes against the intent of the will. So, be careful if you choose this course. If the beneficiaries received a copy of the will, of which they are entitled, then they know a piece of that IRA is theirs. The problem with this will is the Estate as Beneficiary designation. If the decedent listed the beneficiaries on the IRA, this wouldn’t be a decision for you to make. Each benefciary would claim their share on their own. As it is, you would be wise to administer this estate in accordance with the will.
I hope this helps.
Robert
Thank you. Yes, the IRA and all other assets are in probate. The other named beneficiaries are designated to get cash, of which there is enough, without considering the IRA value, to pay beneficiaries, taxes and all admin costs. Yes, the charity is a residuary beneficiary, exempt from taxation. If I take the lump sum and push out all income to all beneficiaries, the individual beneficiaries will have tax impacts. I was trying to be mindful, and if allowable, push the IRA, via beneficiary designation, to the residual charity that is A non-profit entity. All beneficiaries have a copy of the will. I would expect their preference is to inherit cash with no K-1 allocation of taxable income to them. Of course, I would get the attorney to disclose this in the final consents, if went in this direction. But if IRA administrator will not allow me to name the charity as beneficiary, it seems I will be forced to take the lump sum and allocate income among all beneficiaries.
Okay, so this is a tax saving move. Apparently, this is a well funded estate you are handling. Anyway, discuss this with IRA administrator. The issue here is that the inherited IRA is for the estate. The charity would only receive the funds as beneficiary if the estate passed, which doesn’t make sense. So, I am thinking you would have to take the lump sum. However, I would talk to the professionals about this. Admittedly, I never had to deal with this type of issue. Finally, you can elect for the estate to pay the taxes if you feel the taxes are too burdensome for the beneficiaries. Of course, your tax professional should help in this decision.
Yes, it is an odd but large estate. I had read that one could name a beneficiary to the Estate inherited IRA, and at Estate closing, funds can transfer to named beneficiary. I believe finding an IRA administrator to do this may be a problem. But maybe with research and consents and a lot of explanation, I can accomplish. Do you have an opinion on the allocation of K-1 income to beneficiaries? If I had to take lump sum, but had the IRA administrator cut a check direct to the charity, thoughts on allocating all of that income to charity, via K-1?
Sorry Kristie for the delay. My opinion of K-1 income to the beneficiaries is preferable to save on taxes. The K-1 income is taxable at each beneficiary tax rate while the estate income is taxable at the estate tax rate which is equal to the personal highest tax rate. So, estate income is moved to the individual through a K-1 to save on taxes for those beneficiaries that are below the personal top rate. Overall, this move saves on taxes to the estate.
There seems to be a bit of confusion about the IRA in what I am trying to tell you. The administrators of the IRA are the people that handle the IRA for the financial institution that holds the IRA. All you have to do is call the financial institution and tell them you are a PR of an estate and have a question about an IRA. Then, they will walk you through the steps on how to distribute the IRA to a charity. So, there is no administrator you have to hire to disperse the funds to the charity. Also, charities do have to pay taxes on funds received from an inheritance if named as a beneficiary. Therefor, you have to contact the charity and get the tax id number and where to send the check.
In the estate I handled, there was no closing where checks were dispersed. In Massachusetts, in a probated estate, you submit a final accounting to the probate court and beneficiaries, which includes all future distributions, and wait for all the beneficiaries to approve of the accounting. Once all the assents reach the court, you’ll receive notice from the court that the estate is closed and you can make all the final distributions. However, the estate was small compared to what you are dealing with, so the rules may be different for you in how to close an estate.
Robert
Hi Robert,
An IRA account holder died in 2006. The IRA account was renamed or transferred to his estate. The executor did not address until 2022, and then had the custodian distribute 1/2 of the account to his 2 children beneficiaries directly. The 1099 just received lists the estate EIN as the payee.
First, can form 1041 still be filed for an estate this old? If so, can the 1041 distribute out on form K-1 to the beneficiaries their 1/2 each of the distribution so that it is taxable at the beneficiary level?
Thanks, Lee
Hi Lee,
Unfortunately, I can’t give you a complete answer because part of this question is above my knowledge level. I can tell you that the IRA distributions can pass through to beneficiaries using the K-1 from the 1041 to use the personal tax rates of the beneficiaries.
The reason I can’t answer the rest is that the estate was setup with an EIN number in which the executor must do. So, the executor has been engaged and can elect to handle the IRA through the estate. However, any IRA in the estate must be fully distributed in five years, unless that changed with recent legislation from congress. Also, since the IRA went to the estate, the account must be probated. You never mentioned if this occured. So, there are some inconsistencies with this question that goes against Estate law. For instance, if the executor applied for an EIN number with the IRS and established a legal estate, taxes and other debts need to be paid before any distributions are made. It’s not illegal to distribute the IRA, but the executor can come up short of money from the estate if they decide to distribute early. Also, tax filing deadlines have to be met. The 1041 has a deadline of 13 months after the date of death. However, since the IRA wasn’t distributed until recently, I am not sure if that deadline gets deferred.
In short, a lot of this question depends upon how the executor elected to handle this estate and the estate laws of the state in which the estate resides. Unfortunately, I don’t have that information to give you a complete answer.
Thanks for your question.
Robert
Hi Robert,
Thank your for your informative article. I am an executor of an estate where the Beneficiary of the IRA is the estate. There are only 2 beneficiaries in the will and both are in significantly lower tax brackets than the 40% estate tax.
The current custodian will not allow the estate IRA to change or transfer from an inherited IRA in the name of the estate to an inherited IRA’s for the benefit of the estate beneficiaries. You state that the executor will have to shop for a custodian that will allow inherited IRA’s for the benefit of the estate beneficiaries.
Would you have any suggestion as to IRA custodians that will allow a transfer from the inherited IRA for the estate to the inherited IRA for the beneficiary. I have been searching but so far I have not found one that will do it. This is a complex subject so I get quite a few questions but no solid answers. I need to find a custodian that I can show your article to and they will follow what is listed in your article. Would you know a custodian that you have worked with that will do what you list in your article? Any suggestions?
Thanks,
Michael Flickinger CPA
Hi Michael,
Unfortunately, I don’t have experience shopping for custodians because I had too many beneficiaries. So, I opted for the lump sum and passed the tax liability to the beneficiaries to avoid the high estate tax rate. Most banks usually go by their IRA rules and may refuse to accept an IRA from a different custodian without beneficiaries. The only suggestion I have is to try the bank you use for your estate account. They may help you out since you are giving them the use of your estate funds.
Robert
Robert,
You mention that executor needs to consider how many beneficiaries there are before electing to take the lump sum or converting into a an inherited IRA for the beneficiaries? Is there a time in your opinion the executor can get in trouble for electing to take the lump sum? How may beneficiaries would be considered too many in your opinion?
Thanks for the great article!
Hi Alex,
Thank you for your question. When the estate is the beneficiary of a traditional IRA, usually the IRA agreement will dictate the handling of the IRA. In this instance,the IRA agreement will most likely force the executor to take a lump sum. Therefore, the executor will never get in trouble for electing to take a lump sum if the estate is the beneficiary.
However, if the executor wants to distribute the proceeds from the Inherited IRA to a separate IRA account for each beneficiary, the executor must find an institution that will serve as custodian to the account for each beneficiary. So, if you have more than one or two beneficiaries in the estate, you may have a hard time finding custodians to set up IRA’s for your beneficiaries in my estimation. In my situation I had 20 beneficiaries, including two charities. So, I took the lump sum and called it a day.
Thanks so much Robert! Have you seen this issue litigated whether the executor has acted rightfully? I’m just a curious law student!
No, I haven’t heard of any litigation regarding this matter specifically. Typically, custodians of IRA’s are straightforward about the rules and executors usually act accordingly.
My father passed in May 2018. He had several IRAs but a large one did not have a living beneficiary and went to the estate. I did not know that the estate would have to pay a much larger tax on the distribution but I am now past the 65 day post year end cut off to distribute to the beneficiaries. How do I handle this to minimize the tax burden?
Hi Judy,
Thank you for your question. Unfortunately, most common executors will have many surprises during their administration. In your case, I am not aware of any 65 post year cut off date. I had a similar situation in the estate I handled. However, there was no cut off date to distribute the IRA to the beneficiaries. This is where your question lacks context. Is the cut off date rule set by the IRA agreement? Estate law in your state? Or, the fact you set up the estate for a calendar year instead of a fiscal year? Regardless, estate income tax rates are the same as personal tax rates, but more compact. In other words, you will reach the top income rate once the taxable amount reaches $12,500.00. Since you mentioned the IRA was large, you’ll be paying the top rate on any amount over $12,500.00. To minimize the tax amount, pass the tax to the beneficiaries. By doing this, the taxable amount will revert to the lower personal tax rates of the beneficiaries. You will need an accountant to file the fiduciary returns (estate income tax returns) and the accountant will send a schedule k1 to each beneficiary showing their share of the income. I know you probably don’t want to pass the tax to the beneficiaries. I fought hard not to do it myself. However, the beneficiaries will receive more of the asset than the IRS, and I think that would be your father’s intention.
I hope this helps.
I received a lump distribution from my sisters ira that I inherited in 2018 she was 65 and a half, can I still transfer the inherited amount before april 15 2019 into an inherited ira, as I have already received a 1099 R FORM and it says the whole amount is taxable?
Hi Henry,
Thank you for your question. If you received a lump sum distribution from your sisters IRA that means the financial institution fully distributed and closed the IRA. So, transferring funds from the IRA to an Inherited IRA is no longer an option. Although the IRS has rules to make transfers to an inherited IRA, financial institutions operate according to their IRA agreements. Based on the information you gave me, I am assuming that the financial institution distributed the IRA to the beneficiaries once they heard of your sister’s death. Unfortunately, the lump sum amount is fully taxable to you at your ordinary income tax rate.
Hi Robert: We have an unusual situation in that in May of this year, our 90 year old Mother and Father both passed away within 6 days of each other (Dad passed first). Although myself and two brothers were beneficiaries on Dad’s two traditional IRA’s, Mom was the primary beneficiary. Since she never had the opportunity to collect the IRA’s and name her own beneficiaries, both banks informed us they are only payable to Mom’s estate in lump sums. We did collect one of the IRA’s, but were going to wait until the start of 2019 to collect the other to put the proceeds in another tax year. Would there be a penalty for not collecting anything on the second IRA 8 months later in a new year as it is only payable to the estate? Any input would be greatly appreciated. Jim Kelley, executor.
Hi Jim,
Sorry to hear you lost both parents in a short period of time and having to deal with both estates. It’s a tough situation for sure. As to your question, as the long as the estate remains open you can defer collecting an asset without penalty. Unfortunately, you can’t close an estate without paying all debts and taxes and that includes the taxes on both IRA’s. You may want to consider the amount of tax you will have to pay as opposed to when you will pay the tax. When considering the two options, Required Minimum Distributions should play a part in your decision. Accordingly, your Father was 90 and should have been receiving RMD’s from both IRA’s for nearly 20 years. You need to find out from the bank if your Father received his RMD from the uncollected IRA in 2018. If not, you will need to collect that income, which will be taxable to the estate. If he did, then you should collect both IRA’s to avoid another distribution in the coming year. So, keep the RMD’s in mind when deferring IRA income of the estate. Finally, the fiduciary returns or estate income tax returns are complicated at the federal level. If you haven’t already, you should consult a tax professional regarding your situation.
I hope this helps.
Robert
Robert,
Thank you for your response. I believe however the conclusion is not correct. Naming an estate looses the ability to stretch but does not disallow the plan being distributed in tact per se. Many providers won’t allow it based on their internal operations but it appears that sources exist to allow the plan to be transferred out to underlying beneficiaries who then use the deceased’s measuring life for RMDs.
See in particular, PLR 201208039. Natalie Choate states it this way “An IRA is transferable. The owner of an IRA (whether such owner is the participant or the beneficiary of the account) can transfer ownership of the account to another person or entity…..the question is not whether the account can be transferred; the question is whether such transfer will terminate the account’s status as an IRA causing an immediate distribution…” The conclusion is that it does not. Granted much of the support is found in PLRs which are not citable authority but it appears the transfers are in fact done.
Beverly DeVeny, in an article states “Does the estate have to remain open for the next 15.3 years (decedent’s measuring life) 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 (decedent’s) life expectancy. Now the estate can be closed.
I would appreciate any authority that says an IRA transfer out of an estate intact is not allowed so I can contrast that to my current understanding.
I do appreciate your article and am just attempting to reach clarity for my better personal understanding. In full disclosure, I have not read any of the PLRS in Natilie’s book in quite sometime but again, her conclusion is that an IRA can be transferred intact. Thank you again.
Diane, your point is exactly right. The age of the decedent determines how the Inherited IRA can be distributed. In terms of being transferred in tact, I guess the process of converting the original IRA to an Inherited IRA and transferring the funds to the Inherited IRA is keeping the IRA in tact. However, once the Inherited IRA is in care of a beneficiary, distributions have to be taken accordingly.The idea of the entire transfer process is close out the account and have the beneficiary pay the taxes in the time period they choose according to IRA rules. Also in play is the IRA rules each custodian sets up. For instance, not all custodians offer the options to set up multiple Inherited IRA’s for many beneficiaries for an IRA. Basically, we agree on how this works. Perhaps something was lost in translation. In the article, rules for distribution were set out for decedents under the age of 71 1/2 and for decedents over the age of 71 1/2. For decedents over 71 1/2, the beneficiary may receive RMD’s according to the decedents life expectancy rate. This option isn’t available for decedents under the age of 71 1/2 because they weren’t required to take distributions while alive. Anyway, my references for this article have links at the end. The best link that summarizes the rules for the decedents age is the chart by Charles Schwabb. That may clarify this topic for you.
Robert,
I am just curious if you are familiar with distributing the account, in tack, to the estate beneficiaries. This allows for avoiding a lump sum distribution on the entire amount as well as allows estate wrap up.
I am just wondering if I missed something in the article.
Thanks for your information.
Hi Diane,
Thanks for your question. In short, you can’t keep the original IRA in tact when distributing to estate beneficiaries. The IRS will allow you to setup an Inherited IRA and transfer the assets from the original IRA to the new Inherited IRA. So, if beneficiaries are listed on the original IRA, all you need to do is inform the beneficiaries to contact the bank and claim their portion of the IRA. At that point, the beneficiary will decide whether to take the lump sum or stretch out distributions for five years. Conversely, if the beneficiaries are listed in the will, you will be able to handle the paperwork to setup the Inherited IRA. You will have to set this up for each beneficiary. The paperwork gets tedious. Basically, the IRS requires the Inherited IRA to be fully distributed in five years.