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inherited IRA

My Estate is Beneficiary of My IRA

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When an estate is named beneficiary of an IRA, what is the method of distributing it to one individual in the most tax-effective way?

If my estate is the beneficiary of my IRA, the income tax results can be disastrous.

The named beneficiary of an IRA can have important tax consequences, says nj.com’s recent article entitled “How is tax paid when an estate is the beneficiary of an IRA?”

If an estate is named the beneficiary of an IRA, or alternatively if there’s no designated beneficiary, the estate is usually designated beneficiary by default. In that case, the IRA must be paid to the estate. As a result, the account owner’s will or the state law (if there was no will and the owner died intestate) would determine who’d inherit the IRA.

An individual retirement account or “IRA” is a tax-advantaged account that people can use to save and invest for retirement.

There are several types of IRAs—Traditional IRAs, Roth IRAs, SEP IRAs, and SIMPLE IRAs. Each one of these has its own distinct rules regarding eligibility, taxation, and withdrawals. However, if you withdraw money from an IRA before age 59½, you’re usually subject to an early-withdrawal penalty of 10%.

A designated beneficiary is an individual who inherits the balance of an individual retirement account (IRA) or after the death of the asset’s owner.

However, if a “non-individual” is the beneficiary of an IRA, the funds must be distributed within five years, if the account owner died before his/her required beginning date for distributions, which was changed to age 72 last year when Congress passed the SECURE Act.

If the owner dies after his/her required beginning date, the account must then be distributed over his/her remaining single life expectancy.

The income tax on these distributions is payable by the estate. A compressed tax bracket is used.

As such, the highest tax rate of 37% is paid on this income when the total income of the estate reaches $12,950.

For individuals, the 37% tax bracket isn’t reached until income is above $518,400 or $622,050 if filing as married.

The estate tax brackets can be avoided if the estate planning allows the personal representative to distribute the income and along with it the income.

Additionally, an estate can only withdraw the IRA over a five-year time, at the longest. However, to close the estate, they accounts are often withdrawn entirely at once, making the payment of income taxes much faster than allowable. See the choices otherwise in the article about the Secure Act. 

Therefore, you can see why it’s not wise to leave your IRA to your estate. It’s not tax-efficient and generally should be avoided. Consult an estate planning attorney to verify that your beneficiary designations are tax-efficient and meet your planning needs.

Reference: nj.com (Feb. 26, 2021) “How is tax paid when an estate is the beneficiary of an IRA?”