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Posted by Jim McClaflin, EA, NTPI Fellow, CTRC

Important IRA Rules for all Beneficiaries

Important IRA Rules for all Beneficiaries

You open an individual retirement account known as an inherited IRA on inheriting a tax-advantaged retirement plan like an IRA or 401(k). The heir needs to transfer such assets from the original owner's account to an IRA account newly opened for the heir.

The heir to the IRA can be anyone; however, the treatment differs depending on your relationship with the owner. As a result, this article sheds light on key things to know about treating such inherited accounts.


  1. Spouses are entitled to the most leeway.

Assuming someone inherited an IRA from their dead partner, there are several things the survivor can do with such an account:

  • Consider and operate the IRA like it's your own; tune and name yourself the owner.

  • Consider the account like yours by directing it into another account like a qualified employer plan.

  • Transform yourself to the plan’s beneficiary

Whatever action you decide to go with might warrant extra steps to take.

For instance, for someone who is the primary beneficiary and considers an IRA as theirs, taking the Required Minimum Distribution is compulsory, based on the age. There could be an option not to withdraw funds in the right case. 

Also, spouses can roll such IRA into a personal account that changes everything. This gives them the power to name their beneficiary who will succeed them and handle the IRA like it's theirs.


  1. Take Note of Year-of-Death Required Distributions 

One primary consideration for traditional IRA beneficiaries is determining if the benefactor already took the RMD in the year they died. The beneficiary needs to do this if the account owner has not, which helps ensure they already met the minimum. 

Even due to ignorance, failure to do this can trigger a 50% penalty on the failed distribution amount. However, a benefactor that dies pretty late in the year could pose issues as you might not even have enough time to know you are the beneficiary, let alone take the distribution. 

However, if the deceased did not have to take the RMD, you need not worry about the year of death required distribution.


  1. Take all the Tax breaks You get

For all estates that are bound with the estate tax, inheritors will have an income tax deduction for the tax paid on the account. Any taxable income you earn is known as income in respect of the decedent.

On taking your distribution from the IRA, such can be taxed. However, the fact that such estate needs to pay federal estate tax will get an income tax deduction for all estate tax paid on the IRA.

You might not be the person who pays the tax, but someone needs to. In 2021, estates that are worth above $11.7 million must pay estate taxes.


  1. Take Care of all beneficiary Forms.

Your estate plan can suffer significantly due to a missing, ambiguous or incomplete beneficiary form. Yet, many people assume they fill the form correctly. 

They can't correctly say who their beneficiary is even though they assumed they already completed the form. However, the form is neither on record nor with the custodian, which creates issues. 

In the absence of a beneficiary form and the account was transformed to the estate, the beneficiary will have to deal with a five-year distribution rule. 

As simple as the form is, any mistake could lead to mishandling a large sum of money.


  1. Wrongly Drafted Trust is bad.

One can have a trust as the primary beneficiary of the IRA, and this could go wrong. Any error might have an effect and limit the options the beneficiary has.

In a case that a trust does not draft its provision carefully, it might be hard for a custodian to examine the trust and determine the rightful beneficiaries. This case will, however, trigger the IRA’s accelerated distribution rule.

This makes it essential to enlist the service of an experienced lawyer well versed in the rules binding the transfer of IRAs to trusts. The absence of a capable professional can make it difficult to get it.


FOR MORE INFORMATION ON HOW JIM McCLAFLIN, EA, NTPI FELLOW CAN BEST HELP YOU WITH YOUR TAX FILING NEEDS, PLEASE CLICK THE BLUE TAB ON THIS PAGE.


THANKS FOR VISITING.

Jim McClaflin, EA, NTPI Fellow, CTRC
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