Start the year off right! If you're a beneficiary of an IRA, have inherited an IRA, or have an IRA and want to ensure it goes to the right people, understanding your options is crucial. There's a lot to consider, so let's break it down.
“Inherited IRAs” and “Beneficiary IRAs”— these are both industry terms used to describe an IRA that has been inherited after the death of the original account holder. These terms can be used interchangeably but do not describe the tax status of your account— if you are unsure what type of account you hold or inherited, you should check with the IRA provider.
Here is a complete guide on what you need to know if you are a beneficiary or if you are deciding who to name as your self-directed IRA beneficiary.
TOPICS:
- Why You Should Update Your Beneficiaries
- Who Should You Name
- Primary Beneficiary vs Contingent Beneficiary
- Spouse and Non-Spouse Beneficiary
- Moving The Beneficiary IRA
- Other Beneficiary IRA Rules
- Taxes Due
- SECURE Act 2.0 the 10-year rule
Why You Should Update Your Beneficiaries— Even if You’ve Updated Your Will
For IRA holders updating the beneficiary designation form is essential because the beneficiaries listed on the IRA supersedes a will or trust. This means that even if other end-of-life documents are updated, the IRA holder will need to make sure that the IRA beneficiary designation form is updated as well.
In the industry, we hear stories of long-estranged ex-spouses inheriting IRAs intended for others, all due to outdated beneficiary information. To make sure this doesn’t happen, the IRA holder must make sure their IRA beneficiary designation form is up to date. This information can be updated by filling out and submitting a Beneficiary Form as soon as your selections change. If a trust is listed as a beneficiary, a copy of the trust documents must be included as well.
Who Should You Name as Your Beneficiary?
Who you choose as your beneficiary and how you choose to distribute your IRA can make a big difference. You can name multiple people or organizations as beneficiaries, and the specific details of your designations will determine who gets what. Here are some common examples of who we see listed as beneficiaries:
- Your Spouse
- Your Children, Grandchildren, or Other Individuals (i.e. friends)
- Trusts
- Charities
Primary Beneficiary vs Contingent Beneficiary
There are generally two types of beneficiaries “Primary” and “Contingent” beneficiaries.
Primary Beneficiary
A primary beneficiary is the individual (or in the case of a trust, the legal document) that you want to receive the assets in your IRA first in the event of your death.
You can have more than one primary beneficiary— it doesn’t have to be all or nothing. You can choose 100% of the IRA to be paid to one person or split the IRA into percentages for each beneficiary (for example, a 50/50 or a 75/25 split).
If you name several primary beneficiaries and one dies before you, then that person's share is divided proportionately among the surviving primary beneficiaries (unless you say otherwise). If the primary beneficiary is a trust, we typically see the trust as a 100% primary beneficiary (since the trust will specify how you want the IRA assets distributed).
Contingent Beneficiary
A contingent beneficiary is an alternate person(s) or in the case of a trust, the legal document, who receives the assets in your IRA if none of your primary beneficiaries survive you.
An example we see regularly is listing a spouse as the sole primary beneficiary and the children of the IRA holder as the contingent beneficiaries. This way, if the primary beneficiary (the spouse) passes first, the children are already listed as contingent beneficiaries, and no updating is needed.
The Differences Between Spouse and Non-Spouse Beneficiary IRAs
The options of a beneficiary depend on who is inheriting the IRA. The biggest difference is if the beneficiary is a spouse or not.
The spouse can leave their inherited assets in the inherited account and receive penalty free distributions if the surviving spouse is under the age of 59 ½. The other option is to treat the inherited accounts as if they were his or her own.
This means the spouse can transfer the assets into their own existing or new IRA. The money is available to them at any time, however will now be subject to their own distribution rules If the money is taken out (distributed) before the spouse is 59 ½ Traditional IRA—this is still considered an early withdrawal and the penalty will apply.
Opening a Beneficiary IRA
The process for opening a Beneficiary IRA at IRAR is the same as any IRA. In addition to the online new account application, we’ll need the original death certificate for the IRA account holder (we will return the death certificate once we have verified its legitimacy).
The primary difference during this process is that the Beneficiary IRA is titled differently than an IRA you would open normally. The deceased IRA account holder’s name is a part of the title on the Beneficiary IRA.
Example: IRA Resources FBO Jane Doe as beneficiary of John Doe
Even though the account titling is different, and a death certificate is required, we don’t charge extra for a Beneficiary IRA. The fees for a Beneficiary IRA are the same as our other IRA accounts. Learn more about our fees.
What to Do with The Inherited IRA
Both spouse and non-spouse beneficiaries inheriting an IRA from an account holder who died before reaching age 73 (and before the Required Beginning Date for Required Minimum Distributions) have the following options:
Moving The Beneficiary IRA
The spouse and non-spouse beneficiary have different options when it comes to moving the inherited IRA funds.
Non-spouse beneficiaries need to transfer directly from one account to another, or from one IRA custodian to another. Unlike the spouse beneficiary, the non-spouse beneficiary doesn’t have the option for a distribution or a 60-day rollover when inheriting IRA assets.
Spouse: Can treat the IRA as their own or Distributions must begin no later than December 31st of the year the account holder would have reached 73, with the annual distributions spread over the beneficiary’s life expectancy.
Non-spouse beneficiaries less than 10 years younger: Minors and Chronically ill or disabled beneficiaries - Must start taking distributions based on their life expectancy. If there are multiple beneficiaries, separate accounts for each beneficiary must be established by December 31st of the year following the year of death to be able to use each individual’s own life expectancy.
Non-spouse beneficiaries more than 10 years younger: Are required to distribute all funds by the end of the 10th year of the account holder's death. However, annual RMDs may also apply depending on whether the account holder had already begun taking the required minimum distributions (RMDs) before passing.
Non-individuals - Beneficiaries such as Charitable Institutions or Trust: Have these options:
- 5-Year Method option. The money is available at any time, up until December 31st of the fifth year after the year in which the account holder died, at which point all assets need to be fully distributed.
Lump Sum Distribution: This can be done by any beneficiary that doesn’t open an Inherited IRA.
- All the assets the IRA owned are taken out immediately.
- The beneficiary will be taxed on the distribution, but will not have to pay the 10% early withdrawal penalty
Other Beneficiary IRA Rules and Example
If the account holder was older than 73 at the time of death, the beneficiary no longer has the option to avoid taking annual distributions. The 5-year rule, which allows the beneficiary to withdraw the entire balance by the 5th year without taking annual distributions, is no longer available in this case. The other options mentioned earlier still apply. If you’d like additional information about the IRS rules and regulations around beneficiary IRAs, they have resources here.
If a non-spouse beneficiary takes a distribution (assets or a check), not only is the distribution taxed as ordinary income, but it is also not eligible to be rolled into the Beneficiary IRA it was originally taken from or one at another firm. A non-spouse beneficiary can NEVER do a 60-day rollover of Beneficiary IRA funds.
If you inherit IRAs from different owners, you cannot combine them into a single inherited IRA because of the titling requirements mentioned above. If you have inherited multiple IRAs (of the same account type) from the same original owner, you can combine them.
Example: If a beneficiary inherited two IRAs of similar types from their mom (a non-spouse beneficiary), they can be combined into one beneficiary IRA. If at some later point, the same beneficiary inherits an IRA from their dad (who had also inherited an IRA from Mom), this IRA comes from Dad, not Mom. It cannot be combined with those previous two IRAs inherited, even though they were all Mom’s IRAs at one point. The main reason for this is that the Required Minimum Distributions (RMDs) on the inherited accounts will be calculated differently. RMDs on accounts that are inherited directly are generally based on the beneficiary’s age in the year after the account owner’s death.
Taxes Due When Distributing Inherited IRAs
Whether or not you’ll owe taxes on an inherited IRA depends on the type of account you have inherited. With an Inherited Traditional IRA, the beneficiary will pay taxes on any distributions they take. With an Inherited Roth IRA, they generally don’t pay taxes on distributions, just like a regular Roth IRA. A Beneficiary IRA maintains the tax advantages (Traditional or Roth) of the original account.
Non-spouse beneficiaries greater than 10 years younger of Roth IRAs must fully distribute the account within 10 years of the account holder's death under the SECURE Act, but the distributions remain tax-free as long as the account has met the 5-year holding rule.
NEW: SECURE Act 2.0 the 10-year rule
Recent changes to retirement laws, like the SECURE Act and SECURE 2.0, have affected how inherited IRAs are handled. These changes, especially the 10-year rule for distributions, could impact your financial plan.
A non-spouse beneficiary who is more than 10 years younger than the deceased must generally withdraw all funds from inherited IRAs (including Roth IRAs) within 10 years.
If they qualify as an eligible designated beneficiary (e.g. spouse, non-spouse less than 10 years younger, minor child, or a chronically ill or disabled individual) this doesn’t apply.
Key Take Aways
Who you name as your beneficiary is important and keeping that information up to date is crucial. While most rules apply to all beneficiary IRAs, there are key differences between spousal and non-spousal beneficiaries.
To ensure your hard-earned savings go to the right people, make sure your IRA provider has the correct beneficiary information on file. If you have any questions or need assistance, please contact us.
Update your beneficiary information today for peace of mind.
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