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Taking the Mystery Out of Inherited IRAs and the Stretch Strategy
IRA holders generally name beneficiaries
to inherit the assets in their Traditional, Roth, SEP, or SIMPLE IRA.
Beneficiaries are required to eventually take Required Minimum
Distributions (RMDs) from an inherited IRA, and the amount and payout
period, after the IRA holder�s death, depends on who is designated as the
IRA beneficiary(ies) and their age at the time of the IRA holder�s death.
To manage taxes, most beneficiaries
choose to take the smallest payment that the law allows, and at the latest
possible date, which allows the IRA the potential to grow tax deferred
over their lifetime.
Inheriting an IRA
If a spouse is named as the
primary beneficiary of an IRA, they have the following options after the
holder�s death:
�
Lump-sum distribution
�
Establish a beneficiary IRA
account and eventually begin RMDs
�
Deplete the entire balance
before the end of the fifth year following the year of the IRA holder�s
death (available if the IRA holder had not started RMDs, i.e., died before
age 70�, or the inherited IRA is a Roth IRA)
�
Roll the assets into their
own IRA (and name their own beneficiaries)
A rollover is the most popular choice, as
it could possibly stop or slow RMDs that were currently being taken by the
now deceased IRA holder. When the spouse beneficiary turns 70�, RMDs must
begin using the IRS Uniform Lifetime Table to determine payouts.
After the spouse beneficiary�s death, the assets pass to his or her own
designated beneficiaries.
Non-spouse
beneficiaries who inherit IRAs do not have the rollover option.
However, the following options are available:
�
Lump-sum distribution
�
Deplete the entire balance
before the end of the fifth year following the year of the IRA holder�s
death (available if the IRA holder had not started RMDs, i.e., died before
age 70�, or the inherited IRA is a Roth IRA)
�
RMDs based on their own life
expectancy, determined by referencing the IRS Single Life Expectancy
Table
Stretching an IRA
To �stretch� is a strategy to distribute
the IRA assets well beyond the lifetime of the person who established the
IRA. In order to do this, after the holder�s death:
- The designated
beneficiary(ies) chooses to take RMDs based on their own single
life expectancy and must begin by December 31 of the year following the
IRA holder�s death.
- Upon inheriting
the IRA, the beneficiary is allowed to name their own beneficiary(ies)
through a designation of beneficiary form, if the IRA custodian
permits.
- If the beneficiary
of the inherited IRA dies before reaching their full life expectancy,
the IRA assets can continue to be paid to the next beneficiary over the
remaining distribution period of the deceased beneficiary.
As an example, an individual who is age
70� names a grandchild who is 15 years old as a beneficiary. While the
IRA holder is alive, the RMDs are paid over a 27.4-year period (Uniform
Lifetime Table factor). After five years, the IRA holder dies. The
beneficiary, who is now 20, must continue to take RMDs in the year
following the IRA holder�s death. However, the payments will now be based
on the grandchild�s own single life expectancy factor, which is 62.1 years
(IRS Single Life Expectancy Table) for someone age 21. And, if the tax
laws don�t change, the 62.1 years is a guaranteed payout period to the
beneficiary or to the beneficiary�s named beneficiary(ies).
RMD taxation and penalties
Although distributions are taxed at the
beneficiary�s tax level, the 10% penalty associated with IRA distributions
to those under 59 � years of age is not applicable for inherited IRA
distributions. However, failure to take a RMD will result in a 50% excise
penalty tax on the undistributed amount.
Distribution Reference Chart
The following chart may be used to
determine inherited IRA Required Minimum Distributions. Beneficiary
options vary depending upon if death occurred before or after the IRA
holder reached their Required Beginning Date (RBD). Note that a
beneficiary�s age as of December 31 of the year of distribution is used to
determine the life expectancy (LE) factor for RMDs.
|
Beneficiary |
Death Before RBD |
Death After RBD |
|
Spouse |
�
Total distribution
�
Five-year rule
�
LE payments based on own LE beginning in the year following the year
the IRA owner would have turned
70 �,
recalculated each year
�
Roll over into their own IRA |
�
Total distribution
�
First distribute RMD for year of the IRA holder�s death based on
decedent�s LE
�
Continue RMDs based on the longer of the deceased IRA holder�s LE
(reduced by one each year) or their own LE (recalculated)
�
Roll over the remaining assets into the spouse's IRA |
|
Non-Spouse
and Multiple
Beneficiaries |
�
Total distribution
�
Five-year rule
�
LE payments based on single LE of beneficiary. LE factor is reduced by
one for each subsequent year
|
�
Total distribution
�
First distribute RMD for year of the IRA holder�s death based on the
decedent�s LE
�
Continue RMDs based on the longer of the deceased IRA holder�s LE or
the LE of the beneficiary. LE factor is reduced by one for each
subsequent year |
|
Multiple Beneficiaries Only
|
�
LE payments based on the oldest beneficiary�s LE. If the IRA is
separated into individual beneficiary IRAs by 12/31 of the year
following the year of the IRA owner's death, each beneficiary may use
their own LE |
�
LE payments based on the oldest beneficiary�s LE. If the IRA is
separated into individual beneficiary IRAs by 12/31 of the year
following the year of the IRA owner�s death, each beneficiary may use
their own LE
|
|
Qualified Trust |
�
Total distribution
�
Life expectancy payments based on the oldest beneficiary of the trust
�
For subsequent years, this factor is reduced by one |
�
Total distribution
�
After RMD in year of the IRA holder�s death, subsequent RMDs will be
based on the LE of the oldest beneficiary of the trust. LE factor is
reduced by one for each subsequent year |
|
Non-qualified Trust |
�
Total distribution
�
Five-year rule
�
LE payments not available |
�
Total distribution
�
RMDs to continue based on the deceased IRA holder�s LE as determined
in the year of death. LE factor is reduced by one for each subsequent
year |
|
No Beneficiary Designation |
�
Total distribution
�
Five-year rule
�
LE payments not available |
�
Total distribution
�
RMDs to continue based on the deceased IRA holder�s LE as determined
in the year of death. LE factor is reduced by one for each subsequent
year |
|
Charity |
�
Total distribution
�
Five-Year Rule
�
LE payments not available |
�
Total distribution
�
RMDs to continue based on the deceased IRA holder�s LE as determined
in the year of death. LE factor is reduced by one for each subsequent
year |
|
Estate |
�
Total distribution
�
Five-Year Rule
�
LE payments not available |
�
Total distribution
�
RMDs to continue based on the deceased IRA holder�s LE as determined
in the year of death. LE factor is reduced by one for each subsequent
year |
This
information is for educational purposes only. It is always recommended
that you seek the aid of a competent tax advisor or tax attorney to assist
you with tax advice and guidance. |
