For purposes of this blog entry, the discussion below assumes the IRA owner died after reaching age 70 ½.
When a spouse is named beneficiary
Naming one’s spouse as the beneficiary of an IRA provides many options and flexibility for the surviving spouse. A spouse is the only beneficiary who can choose to rollover the decedent’s IRA and treat the IRA as his or her own, which means the spouse can delay taking required minimum distributions (“RMDs”) until he or she reaches age 70 ½. The beneficiary spouse can also choose to establish an inherited IRA, which requires him or her to start taking RMDs in the year following the death of the IRA owner, but the RMDs are calculated according to the surviving spouse’s age/life expectancy. The surviving spouse can always take a lump-sum distribution, although this will cause the entirety of the distribution to be subject to income tax in the year in which such withdrawal occurs.
When a non-spouse is named beneficiary
A non-spouse beneficiary can either take a lump sum distribution or open an inherited IRA using his or her life expectancy, as determined by his or her age in the year following the year of death of the IRA owner. If multiple beneficiaries are named, they must establish separate inherited IRA accounts by December 31 of the year following the year of death of the IRA owner. If the beneficiaries fail to establish separate accounts by that deadline, distributions to all of the beneficiaries will be based on the oldest beneficiary’s life expectancy.
When a charity is named beneficiary
If you are charitably inclined, naming the charity as beneficiary of a retirement account is tax efficient for both the donor and the donee. The charity pays no income taxes upon receipt of the IRA assets, and the IRA will qualify for a full charitable deduction in the IRA owner’s estate.
When a trust is named beneficiary
If the trust qualifies as a “look-through” trust, then the RMDs must be paid to the trust over the life expectancy of the oldest trust beneficiary. A “look-through” trust (1) must be valid under state law, (2) must be irrevocable upon the death of the IRA owner, (3) the individual beneficiaries of the trust must be identifiable and (4) trust documentation must be provided to the IRA custodian no later than October 31 of the year following the year of the IRA owner’s death. If there are several trust beneficiaries of varying ages, then the ability to maximize the deferral potential of the distributions from the IRA could be lost. It is important to note that it may be possible to “split” beneficiary accounts if the trust creates separate “subtrusts” for each trust beneficiary. If the trust is not a “look-through” trust, then the time period to pay out the IRA is within five (5) years following the year of the IRA owner’s death.
When an estate is named beneficiary
Generally speaking, since an “estate” is not an individual, an IRA that names the owner’s estate must be paid out within five (5) years following the year of the IRA owner’s death.