IRA Inheritances And Tax Strategy

Recently, the Senate abandoned a proposal to require the complete distribution of IRAs within five years of the deceased owner’s death. The proposal would have eliminated a huge tax advantage under the current law, which permits heirs to take distributions from an inherited IRA across their life expectancies. Currently, at age 70.5 an IRA holder is required to begin taking distributions, the minimum annual amount of which is calculated based on his or her life expectancy. In the event that such person passes away prior to depleting the IRA, there are several possible outcomes, the most common of which are (summarily) illustrated below.

1.  A non-spouse individual is named as beneficiary:  In this case, the person inheriting the IRA begins taking distributions immediately, pro-rated across his or her life, presenting a substantial tax-deferral opportunity.

2.  The deceased names his or her spouse as beneficiary: If the account holder died prior to reaching age 70.5, the spouse may delay the commencement of distributions until December 31 of the year that the deceased would have turned 70.5. Additionally, a surviving spouse is permitted to roll over a distribution into his or her own IRA and name a new beneficiary, with the distribution schedule based on the new beneficiary’s life expectancy.  Moreover, if the surviving spouse is younger than age 70.5 and rolls over the IRA, he or she may delay the commencement of distributions until he or she reaches that age.

3.  The deceased names a trust as beneficiary:  As a general rule, one should not name a trust as an IRA beneficiary. Because a trust is not a person it has no life expectancy, and unless very technical requirements are met, the distributions will be based on the deceased’s remaining life expectancy (which would likely be much shorter than such a person’s children, for example).

4.  The deceased names his or her estate as beneficiary:  This will have the same result as #3 above – distributions to heirs will be required over a period based on the deceased’s life expectancy at the date of death.

Tax planning for retirement benefits is crucial, as they are typically a large portion of an estate, and can be heavily taxed through a combination of federal estate and income taxes and state income taxes. Proper planning can greatly delay and prolong the timetable for required distributions, allowing IRA assets to continue to grow and compound tax-deferred for many additional years.

This blog post grossly simplifies a complex subject.  Speak to an expert at Freed Law LLC to learn more about how the IRA distribution rules may affect you, and for help developing a tax-efficient inheritance strategy.

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