Retirement Weekly: What are the rules when the beneficiary of an inherited IRA dies?
Q.: I appreciate your columns in MarketWatch and thank you for writing them. I recently read one of your columns on inheriting IRAs and it generated a question for our family. My uncle (age 71) recently passed away and left his IRA to my mother, his older sister. My question is, what are the rules when the beneficiary of the inherited IRA passes away?
A.: Hi Fred, Thank you. I’m glad you enjoy them.
I’m sorry to hear of your uncle’s passing. My condolences to you and your family.
First, I will explain the rules then I’ll touch on some strategic issues you should discuss with your adviser.
Because your mom is older than your uncle she is “not more than 10 years younger” than your uncle and is therefore an Eligible Designated Beneficiary (EDB) under one of the qualifications described in the SECURE Act. Because your uncle had not reached his Required Beginning Date (April 1 of the year after the year he turns 72), your mom, as an EDB, has the option to operate under the new 10-year rule or she may “stretch” distributions based on her single life expectancy.
If electing to stretch, your mom would use her age as of Dec. 31 of the year after the year your uncle died and find the factor from the Single Life Table on page 20 of this document from the Federal register. She then divides the value of the account as of Dec. 31 of the year your uncle died by that factor to determine the Required Minimum Distribution. That distribution must be made by Dec. 31 of the year after the year your uncle died.
In each subsequent year she reduces the factor by 1 then takes the value of the account as of the end of the prior year and divides by the new factor. If her starting age for this is 82 or older, the stretch will empty the IRA in less than 10 years.
For instance, if she starts at age 86, the factor is 7.6 the first year, 6.6 the next, 5.6 the next and so on. Now, if your mom’s starting age was say 62, the factor is 25.4 so the percentage of the account that must come out each year is relatively small for younger beneficiaries.
When your mom dies, whoever she named as her beneficiary on the Inherited IRA is a “successor beneficiary.” Let’s say that is you. As a successor beneficiary of an owner of an Inherited IRA that was using the stretch, you are subject to the new 10-year rule and would have to empty the account by the 10th year after the year your mom died. This is the case even if you would otherwise qualify as an EDB.
By contrast, if she opts to go with the 10-year rule herself, she has no requirement to distribute any funds at any time except the account must be fully distributed by the end of the 10th year after the year of your uncle’s death. When your mom dies, successor beneficiaries must assure that the account is empty by the same date your mom had to empty the account.
So, the rules offer very different possible cash flow patterns from the account. If she needs or wants to use the funds for herself, she can take it under either option and she can always take more than is required in any given year. When she takes a distribution, it will be taxable to her.
If she wants to minimize the tax bill that comes with the distributions, the strategic tax planning task here is to lay out the probable cash flows of going one route or the other and overlaying your respective tax rates on those cash flows.
If you expect your mom’s tax rate to be much higher than yours, the method that stretches the payments over the longest period may be the way to go because it minimizes the distributions to her. If your rate is expected to be higher, getting the money out faster at her lower rates may be better. It can be tricky because it can be unclear what your respective tax rates will be in the future and you do not know when your mom or you will pass away. Nonetheless, mapping out the possible cash flows can sometimes help with these decisions.
If you have a question for Dan, please email him with ‘MarketWatch Q&A’ on the subject line.
Dan Moisand is a financial planner at Moisand Fitzgerald Tamayo serving clients nationwide from offices in Orlando, Melbourne, and Tampa Florida. His comments are for informational purposes only and are not a substitute for personalized advice. Consult your adviser about what is best for you. Some questions are edited.