Distribution Options for IRA Beneficiaries

Why must I take distributions from the IRA that I inherited?

IRAs are intended to provide income for the IRA owner’s retirement and, after she is deceased, support of her beneficiaries. IRAs are not intended to permanently shelter savings from income tax. For this reason, the IRS has established distribution rules to ensure that an IRA will be depleted over the course of the IRA owner’s and, if applicable, beneficiary’s life. The distributions that are taken to satisfy these rules are often referred to as life expectancy payments.

What happens if I miss a payment from the IRA that I inherited?

If an IRA beneficiary fails to take a life expectancy payment by the applicable deadline (generally December 31), the beneficiary is subject to a 50 percent excess accumulation penalty tax on the amount that should have been distributed from the IRA. If a spouse beneficiary is the sole beneficiary of an inherited IRA and misses an required beneficiary distribution, however, the IRA ceases to be an inherited IRA and is deemed to be the surviving spouse’s own IRA.

Following an IRA owner’s death, how to I determine what distribution options are available to me as a beneficiary?

Federal regulations provide rules and various distributions options that may be available under IRAs, but financial organizations are not required to provide all of the options. The beneficiary options available are disclosed in the IRA plan agreement, so beneficiaries should review the deceased IRA owner’s IRA documents or inquire with the financial organization that holds the IRA. The distribution options generally vary based on the type of IRA (Traditional or Roth IRA).

There are three primary factors to consider before understanding what distribution options are available.

The IRA owner’s age at the time of death
The beneficiary’s relationship to the deceased IRA owner
Whether the beneficiary is the sole beneficiary

How does the IRA owner’s age at death affect my distribution options as an IRA beneficiary?

If the IRA you inherit is a Traditional IRA, whether the IRA owner died before his required beginning date for required minimum distributions (April 1 of the year following the year in which the IRA owner attained age 70½) may affect the beneficiary options available to you.

If I am the beneficiary of a Roth IRA, what are my distribution options?

Roth IRA owners do not have to take required minimum distributions, so there is no required beginning date to affect the beneficiary options for a Roth IRA beneficiary. Federal laws provide three distribution options for Roth IRA beneficiaries.

A lump-sum distribution by December 31 following the year of death.
Distributions of any amount, at any time, as long as you totally deplete your portion of the IRA by December 31 of the year containing the fifth anniversary of the IRA owner’s death.
Minimum annual distributions based on your life expectancy, begun by December 31 of the year following the year of the IRA owner’s death. Under this rule, however, spouse beneficiaries may wait until December 31 of the year the deceased IRA owner would have turned age 70½ to begin taking beneficiary distributions.

If you are a spouse beneficiary and the sole beneficiary of the IRA, or are one of multiple beneficiaries with separate accounts under the inherited IRA, you also have the options of transferring or rolling over the IRA assets to your own IRA.

The distribution options available to an IRA beneficiary following the death of an IRA owner may be significantly affected by additional factors, including the terms of the underlying IRA investments, the terms of the IRA plan agreement, and the administrative policies of the financial organization.

When determining my required distributions as an IRA beneficiary, what does it mean to recalculate or not recalculate my life expectancy?

Federal regulations governing required IRA distributions provide two basic methods for determining life expectancy distributions: recalculation and nonrecalculation. The recalculation method is used to calculate single life expectancy payments for spouse beneficiaries. A spouse’s payment is recalculated each year using a life expectancy factor found in the IRS’ Single Life Expectancy Table.

The nonrecalculation method is used to calculate life expectancy payments for nonspouse beneficiaries. With this method, the life expectancy factor is obtained from the Single Life Expectancy Table to calculate the first year’s payment. Then for each subsequent year, the life expectancy factor used to calculate the previous year’s payment is reduced by one for the next year’s calculation (e.g., if 10.2 is used one year, 9.2 will be used in the next year).

The life expectancy tables can be found in IRS Publication 590, Individual Retirement Arrangements (IRAs).

What distribution options are available when an IRA owner’s estate is named as a Traditional IRA beneficiary?

Federal regulations provide that distribution options available to an estate that is an IRA beneficiary will depend on whether the IRA owner died before or after her required beginning date (April 1 of the year following the year in which the IRA owner attained age 70½). If the IRA owner died before her required beginning date, a distribution generally may be made at any time in any amount provided the entire IRA is depleted by December 31 of the year containing the fifth anniversary of the IRA owner’s death. If the IRA owner died on or after her required beginning date, the estate generally must take, as a minimum, annual single life expectancy payments over the remaining life expectancy of the deceased IRA owner (nonrecalculated). Of course, an estate may, and often does, take a lump-sum distribution.

What distribution options are available when an IRA owner’s trust is named as the beneficiary of an IRA?

If the trust meets certain requirements outlined in IRS regulations to be a qualified trust, the distribution options may include depleting the assets within five years (if death occurs before the required beginning date for required minimum distributions), or single life expectancy payments calculated by looking through to the qualified trust’s oldest underlying beneficiary’s life expectancy.

It must be valid under state law.
It must be irrevocable, or become irrevocable upon the death of the IRA owner.
The beneficiaries of the trust must be identifiable.
A copy of the trust instrument or qualifying documentation of the trust generally must be provided to the financial organization no later than October 31 of the year following the year of the IRA owner’s death.

When the trust does not meet the IRS’ requirements to be a qualified trust, it may take distributions in one of two ways. In the case of a Traditional IRA, if the IRA owner died before his required beginning date, the trust must deplete the IRA by December 31 of the fifth anniversary year. This also is the only option if a nonqualified trust is the beneficiary of a Roth IRA. If the Traditional IRA owner died on or after his required beginning date, the trust will have to take, as a minimum, annual single life expectancy payments over the remaining life expectancy of the deceased IRA owner (nonrecalculated). Of course, a trust may take a lump-sum distribution at any time.

If I am a Traditional IRA beneficiary, what are my distribution options if the IRA owner died before his required beginning date?

While the IRA plan agreement may be more restrictive, federal rules provide that when an IRA owner dies before his required beginning date (April 1 of the year following the year in which the IRA owner attained age 70½), you generally have three distribution options.

A lump-sum distribution by December 31 following the year of death.
Distributions of any amount, at any time, as long as you totally deplete your portion of the IRA by December 31 of the year containing the fifth anniversary of the IRA owner’s death.
Minimum annual distributions based on your life expectancy, begun by December 31 of the year following the year of the IRA owner’s death. Under this rule, however, spouse beneficiaries may wait until December 31 of the year the deceased IRA owner would have turned age 70½ to begin taking beneficiary distributions.

If you are a spouse beneficiary, and the sole beneficiary of the IRA, or are one of multiple beneficiaries with separate accounts under the inherited IRA, you also have the options of transferring or rolling over the IRA assets to your own IRA.

If I am the beneficiary of a Traditional IRA, what are my distribution options if the IRA owner died after his required beginning date?

As provided by federal laws, when an IRA owner dies on or after his required beginning date (April 1 of the year following the year in which the IRA owner attained age 70½), you generally must begin taking a annual minimum distribution by December 31 of the year following the year of the IRA owner’s death. The annual payments are calculated based on your life expectancy or the IRA owner’s remaining life expectancy, whichever is longer. While a minimum amount is required each year, you can always distribute more than the minimum (including a lump-sum distribution).