Table of Contents
What is an IRA beneficiary?
Who is eligible to be a beneficiary?
Types of IRA beneficiaries
IRA beneficiary rules
Inherited IRA withdrawal rules
FAQs about IRA beneficiaries
Jun 21, 2022
7 min read
The IRS defines a beneficiary as the person or entity who is chosen to receive the IRA funds when the original account holder passes away.
Naming a retirement beneficiary is just as important as the investment process itself. Investors who are years away from leaving the workforce, as well as those already enjoying the perks of retirement, could leave their loved ones with potential financial stress without naming a beneficiary for their individual retirement accounts (IRAs). Instead of the account directly passing to the investor’s chosen recipient, the account could go to the estate, slowing down the distribution process and potentially increasing the tax burden.
What is a beneficiary? For IRAs, the IRS defines a beneficiary as the person or entity who is chosen to receive the IRA funds when the original account holder passes away. Investors can choose both a primary and contingent beneficiary for each IRA account. The primary beneficiary receives all of the IRA funds upon the account owner’s death. But if the primary beneficiary dies first (or decides to disclaim the funds), the IRA will automatically pass to the contingent beneficiary, if one is listed.
Investors are often prompted to choose and update both their primary and contingent beneficiaries. Otherwise they lose control over who would receive those funds. It could go to a default beneficiary, oftentimes the account owner’s spouse. But it could also go directly to the individual’s estate. That can drag the account into the probate process, which proves that a will is legally valid, and can easily last several months to a year, assuming there is no conflict. It could last even longer.
One of the primary benefits of opening an IRA is that it can avoid the probate process entirely, including costly fees assessed on the estate’s assets. But when an investor declines to choose a beneficiary, they automatically forego those benefits. And if a spouse anticipates using those funds as a beneficiary retirement plan, they could be without those funds for a long time while waiting for the probate period to end.
According to the IRS, IRA account owners may choose any individual or entity to be a beneficiary. In states with community property laws, however, a spouse may supersede any named beneficiaries.
In addition to naming a primary and contingent (or secondary) beneficiary, account owners can also name multiple beneficiaries. They can split up the funds either by percentages or by fixed dollar amounts. Each beneficiary doesn’t have to receive equal portions; the account owner can divide up the IRA however they see fit.
There are two types of IRA beneficiaries, each of which has their own set of distribution rules.
When inheriting an IRA, spouses have two options. The first is to roll some or all of the funds into their own IRA within 60 days of receiving the distribution. With this strategy, the required minimum distributions (RMDs) are calculated using the spouse’s age. So if they’re younger than 72, they can delay withdrawing funds.
The other option spouses have is to structure the IRA as an inherited IRA. These RMDs depend on the original account owner:
Non-spouses have fewer options for an inherited IRA. Rather than rolling over funds into their own IRA or taking a distribution within five years, they must do one of the following:
There are many rules for beneficiaries who receive an inherited IRA.
One important detail for beneficiaries to understand is that if the account owner was required to take an RMD in the year they died, but hadn’t taken that distribution yet, the beneficiary must do so before the end of the year.
While IRAs are exempt from the probate process, they may be subject to estate tax. But the beneficiary can take a tax deduction on these costs when they file their personal income tax returns.
Withdrawal rules for inherited IRAs vary based on a number of factors, including the age of the account owner at the time of death and their relationship with the beneficiary (or beneficiaries).
Here’s how withdrawals are treated and taxed for spouses who inherit a traditional IRA.
When a spouse rolls funds into their own IRA, a 10% withdrawal penalty will apply for any distributions made before age 59 ½. Withdrawals are taxed as regular income.
The spouse must start taking RMDs either when the account owner would have turned 72 or by the end of December in the year after their death. Their RMDs will be calculated based on their life expectancy, not the original account owner’s. Withdrawals are taxed, but there is no early distribution penalty.
The entire account must be emptied within 10 years, starting the year after the account owner died. Earnings can continue to accrue during this period. Withdrawals are taxed, but there is no early distribution penalty. This option is not available if the account owner was 72 years or older.
In this scenario, the spouse receives all the funds at once. There is no early withdrawal penalty, but the funds are taxed as income.
Non-spouse beneficiary withdrawals are broken into two categories.
To be eligible, the beneficiary must:
Eligible designated beneficiaries can open an inherited IRA and take distributions using the life expectancy method or the 10-year method. Alternatively, they can take a lump-sum distribution.
If the beneficiary doesn’t meet the previous requirements, the typical withdrawal rules apply: They may either cash out the IRA as a lump sum or take distributions over a 10-year period.
The account passes on to the beneficiary. If no beneficiary is designated, the IRA becomes part of the individual’s estate.
Yes. Naming a trust can protect the IRA from creditors or place more control over how and when the individual beneficiaries take distributions.
are subject to a five-year inheritance rule, meaning the entire account must be distributed within five years of the account holder’s death. Roth IRA distributions are not taxed.
No, an IRA beneficiary form overrides the individual’s will.
Beneficiary rules for a 401(k) plan are similar to IRAs in terms of distributions and taxations. But each plan may also have its own specific rules surrounding the inheritance process.
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