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Leaving assets to your heirs is a great thing, but leaving an IRA to heirs requires knowledge and prior planning, as mistakes can be costly.
If you pass away without using up all of the funds in your IRA, it’s very important that your heirs work with an experienced estate planning attorney so that there are no mistakes made when the IRA distribution takes place. A recent post from Madison.com, “What Happens to an IRA When Its Owner Passes Away?”, poses an important question. If the beneficiary designation form has been correctly completed, that’s great—but there are still steps that have to be carefully managed.
In some limited circumstances, the IRA owner’s will controls who receives IRA funds. But when? What if the IRA beneficiary form wasn’t filed, it doesn’t list a valid beneficiary, or the form lists the estate as the beneficiary?
Beneficiaries inheriting an IRA have a few options. If the decedent hadn’t yet turned 70½, then the beneficiaries can withdraw the entire balance of the inherited IRA within five years. If it’s a traditional IRA, then the beneficiaries pay income taxes on the amount they withdraw in the tax year when they withdraw the funds.
Another alternative: the IRA heirs can start taking regular distributions on an annual basis, using a life expectancy calculation like what IRA owners use when they turn 70½ and must take required minimum distributions from the account. This “stretch IRA” option has the greatest potential tax savings, especially if the heir is young.
In addition to these options, a surviving spouse who inherits an IRA has another option. Instead of treating the deceased spouse’s IRA as a separate account, the surviving spouse can roll the assets over into an IRA in the surviving spouse’s own name. The inherited assets are then treated the same way as any other IRA assets that the surviving spouse might already have owned.
An added detail: make sure that the financial institution properly titles the registration of the account. If the account is not properly named, there could be serious and expensive tax consequences. An experienced estate planning attorney will be able to help guide you through this process.
Reference: Madison.com (February 18, 2017) “What Happens to an IRA When Its Owner Passes Away?”