IRA Beneficiary

Gregory J. Cook, EA, CPA+ Accredited Tax Advisor Past President Alabama Society of Enrolled Agents Past President Alabama Association of Accountants

Naming an Estate as the Beneficiary of a Traditional IRA

It May Not Be The Wisest Choice!


For many individuals, naming a beneficiary on a Traditional IRA may seem like a mere formality. But negative tax consequences exist for those who, on the assumption that their assets will go to their heirs anyway, name their estate as beneficiary instead of an individual or individuals.

When a Traditional IRA holder reaches age 70 1/2, minimum distributions become mandatory and must begin by April 1st of the following year. These distributions are based on the life expectancy of the holder and the named beneficiary if a joint life calculation is selected. A joint life calculation is generally viewed as more desirable because the mandatory payments are lower.

Once the distribution schedule has been established it cannot be changed while the Traditional IRA holder is living except under certain circumstances it may be shortened. If the named beneficiary is the estate, the distributions cannot be based on a joint life (the estate does not have a life expectancy). Therefore, the required distributions will be larger because the life expectancy can only be based on that of the single Traditional IRA holder. For those clients who do not need Traditional IRA distributions as a source of income, having to take larger distributions than absolutely necessary can be frustrating.

When a Traditional IRA holder dies, the distribution of assets is dependent on whether or not the Required Minimum Distributions (RMDs) have begun. If the Traditional IRA holder had not yet reached age 70 1/2 and the RMDs have not begun, the estate is required to take full distribution by December 31st of the fifth year following the date of death. If an individual had been named as beneficiary, he/she would have the option to spread the distributions out over his/her own life expectancy; if the beneficiary were a spouse, the spouse could elect to roll the assets into his/her own Traditional IRA. (The spouse is the only beneficiary who can make this election.) Even though the beneficiaries of the estate will receive their due in the end, the difference between taking distributions within five years or enjoying the benefits of tax-deferred growth through their own life expectancy could be significant.

If a Traditional IRA holder dies after the RMDs have begun, the way in which those distributions have been calculated becomes crucial. If the distribution has been recalculated each year, the estate beneficiary must take full distribution by December 31st of the year following the date of death. This is because re-calculation requires that the life expectancy be "re-calculated" from the IRS Life Tables each year, and when the Traditional IRA holder dies, his/her life expectancy drops to zero. Therefore, the entire balance must be distributed within the year. If the Traditional IRA holder had not been re-calculating and had been using the "elapsed years method" also referred to as "term certain method", the estate is permitted to continue using the same method or distribute at least as rapidly under another method.

The taxation rules applicable to estates and distributions are exceedingly complex. If you have named your estate as beneficiary, the beneficiary designation can be changed up until the point at which RMDs begin. There may, however, be some very good reasons why a tax attorney may advise you to leave an estate beneficiary intact. Therefore, it's important to make certain that you are taking advice from a qualified expert in the estate planning area.

A beneficiary can be any person or entity the owner chooses to receive the benefits of a retirement account or an IRA after he or she dies. Beneficiaries of a retirement account or traditional IRA must include in their gross income any taxable distributions they receive.

IRA Beneficiaries

Inherited from spouse. If a traditional IRA is inherited from a spouse, the surviving spouse generally has the following three choices:

Treat it as his or her own IRA by designating himself or herself as the account owner.


Treat it as his or her own by rolling it over into a traditional IRA, or to the extent it is taxable, into a:
a. Qualified employer plan,
b. Qualified employee annuity plan (section 403(a) plan),
c. Tax-sheltered annuity plan (section 403(b) plan),
d. Deferred compensation plan of a state or local government (section 457(b) plan), or


Treat himself or herself as the beneficiary rather than treating the IRA as his or her own.
If a surviving spouse receives a distribution from his or her deceased spouse's IRA, it can be rolled over into an IRA of the surviving spouse within the 60-day time limit, as long as the distribution is not a required distribution, even if the surviving spouse is not the sole beneficiary of his or her deceased spouse's IRA.

Inherited from someone other than spouse. If the inherited traditional IRA is from anyone other than a deceased spouse, the beneficiary cannot treat it as his or her own. This means that the beneficiary cannot make any contributions to the IRA or roll over any amounts into or out of the inherited IRA. However, the beneficiary can make a trustee-to-trustee transfer as long as the IRA into which amounts are being moved is set up and maintained in the name of the deceased IRA owner for the benefit of the beneficiary.

Like the original owner, the beneficiary generally will not owe tax on the assets in the IRA until he or she receives distributions from it.

Generally, the entire interest in a Roth IRA must be distributed by the end of the fifth calendar year after the year of the owner's death unless the interest is payable to a designated beneficiary over the life or life expectancy of the designated beneficiary.

If paid as an annuity, the entire interest must be payable over a period not greater than the designated beneficiary's life expectancy and distributions must begin before the end of the calendar year following the year of death. Distributions from another Roth IRA cannot be substituted for these distributions unless the other Roth IRA was inherited from the same decedent.

If the sole beneficiary is the spouse, he or she can either delay distributions until the decedent would have reached age 70½ or treat the Roth IRA as his or her own.

Beneficiaries of Qualified Plans

Generally, a beneficiary reports pension or annuity income in the same way the plan participant would have reported it. However, some special rules apply.

A beneficiary of an employee who was covered by a retirement plan can exclude from income a portion of nonperiodic distributions received that totally relieve the payer from the obligation to pay an annuity. The amount that the beneficiary can exclude is equal to the deceased employee's investment in the contract (cost).

If the beneficiary is entitled to receive a survivor annuity on the death of an employee, the beneficiary can exclude part of each annuity payment as a tax-free recovery of the employee's investment in the contract. The beneficiary must figure the tax-free part of each payment using the method that applies as if he or she were the employee.

Benefits paid to a survivor under a joint and survivor annuity must be included in the surviving spouse’s gross income in the same way the retiree would have included them in gross income.