Naming Your Estate as IRA Beneficiary
Naming an estate as an IRA beneficiary is bad estate planning. Or failing to name any
beneficiary, by default, makes your estate the IRA beneficiary. If you name
a person as your IRA beneficiary, that person can make IRA distributions over
their life expectancy and thereby get a lot of value from many years of tax
deferral. But if you name your estate as beneficiary, that flexibility goes
away. Here's what happens.
If IRA owners dies before required beginning date of mandatory IRA distributions
(April 1 of the year following turning age 70.5)
In this case, the IRA must be drained within 5 years and all income taxes
paid (plus estate taxes, due within 9 months of death). This is not good as
the benefit of tax deferral is lost.
If IRA owners dies after required beginning date of mandatory IRA distributions
(April 1 of the year following turning age 70.5)
The beneficiaries may continue to stretch their IRA distributions of the remaining
life expectancy of the IRA owner as if he had lived. For example, Mr. Smith
Dies at age 71. According to the IRA life expectancy tables he has 15 years
to live so his heir will be able to stretch the IRA distributions over the
next 15 years.
The longest possible distribution period for the IRA would then be 15.3 years.
For an IRA owner, the RBD is April 1st of the year after he turns 70½,
which always falls in the second required distribution year. If he turned 70½ years
old in 2004, then the first distribution year is 2004, but the RBD is April
1, 2005, which is in the second distribution year. Death before that date means
he died before reaching his RBD, even if he had already taken a required distribution.
If the IRA owner has passed his RBD and there is no designated beneficiary,
the IRA can be paid out over the remaining single life expectancy of the deceased
IRA owner. The longest possible single life expectancy of an IRA owner who
has passed his RBD is 16.3 years. That’s the life expectancy of a 71-year
old.
IRA Distributions to the beneficiary must begin in the year after the IRA
owner's death and the factor is reduced by 1 each year, so the longest possible
stretch out is 15.3 years, regardless of who ends up inheriting the IRA. It’s
true that an IRA owner could be age 70 in his first distribution year, but
if he died in that year, he would have died before his RBD and the IRA with
no designated beneficiary would have to be paid out under the 5-year rule.
Example:
An IRA owner is 70½ years old in 2005 and for whatever reason has no
designated beneficiary. The default language in the IRA custodial document
says that at his death the IRA beneficiary is his estate. He dies in June 2006,
which is after his RBD of April 1, 2006. If he died in 2005, his first required
distribution year, he would have died before his RBD, and with no designated
beneficiary the heirs of his estate would be stuck with the 5-year payout.
Since he died after his RBD, the IRA can be paid out over his remaining single
life expectancy of 16.3 years based on his age in the year of death (age 71
in 2006). The first post-death required distribution must be taken by the end
of 2007, the year after the IRA owner’s death. For the first beneficiary
distribution, the life expectancy will be 15.3 years (the 16.3 years less one
year). The 15.3 years will be reduced by one for each succeeding year.
The above example illustrates the longest possible payout after death when
there is no designated beneficiary. Most IRAs will be paid out sooner. In case
you were wondering, the shortest possible payout with no designated beneficiary
is not 5 years, but can be even less. If the IRA owner died after age 89, the
remaining life expectancy would be less than 5 years. The single life expectancy
for an 89-year old is 5.9 years. If he dies at age 89, the remaining payout
on the IRA would be only 4.9 years. If he died after reaching 111 years of
age, the entire IRA would have to be paid out in the year following the year
of the IRA owner’s death.
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