Inheriting an IRA Through an Estate

Key Takeaways

• If an IRA is inherited through an estate, the distribution rules for the estate apply, even if the IRA is later transferred to a person.
• Distribution rules depend on whether the IRA owner died before their RBD.
• Mistakes in RMD calculations can result in significant tax penalties.
• Always share the full history of inherited IRAs with any custodian or tax advisor.
• If you’re doing estate planning, work with a tax advisor and estate planning attorney to decide whether naming your estate as the IRA beneficiary makes sense for your estate planning needs.

If an IRA owner names their estate as the beneficiary of their IRA, required minimum distributions after their death must follow either the five-year rule or be taken over the deceased IRA owner’s remaining life expectancy. This remains true even if the IRA is later transferred to a beneficiary IRA for a person who inherits the IRA through the estate.

If you are the beneficiary of an estate that inherits an IRA, and the IRA is transferred to an inherited IRA in your name, it’s important to ensure that the distribution schedule continues to follow the rules that apply to the estate, not the rules for individuals designated as beneficiaries.

Inheriting Through an Estate Means You Are Not a Designated Beneficiary

Your beneficiary class determines the options you have for taking distributions. There are three main classes:

1. Designated Beneficiary: An individual named as the IRA beneficiary at the time of the IRA owner’s death and who remains the beneficiary as of Sept. 30 of the following year.
2. Eligible Designated Beneficiary: A designated beneficiary, who at the time of the IRA owner’s death, is either: the IRA owner’s surviving spouse, disabled, chronically ill, a minor child of the IRA owner, or not more than 10 years younger than the IRA owner.
3. Nondesignated Beneficiary: An entity or person that does not qualify as a designated beneficiary. Examples include estates and charities.

If you inherited an IRA through an estate, you are not a designated beneficiary and must follow the same distribution rules that apply to the estate. You cannot follow the rules that would have applied had you been named as beneficiary of the IRA, even if the inherited IRA is retitled in your name.

Distribution Rules for Nondesignated Beneficiaries

The options for a nondesignated beneficiary depend on whether the IRA owner died before their required beginning date. The question then becomes, what is the RBD?

The RBD is April 1 of the year following the year the IRA owner reaches their applicable age. The applicable age is determined by the IRA owner’s date of birth, and is:

• Age 70 ½ for those who were born before July 1, 1949.
• Age 72 for those who were born on or after July 1, 1949, but before Jan. 1, 1951.
• Age 73 for those who were born on or after Jan. 1, 1951, but before Jan. 1, 1960.
• Age 75 for those who were born on or after Jan. 1, 1960.

Note on Roth IRAs: Roth IRA owners are always treated as if they died before the RBD, since Roth IRA owners are not subject to RMDs.

Distribution Options Based on Date of Death

If the IRA owner died before the RBD, the account must be fully distributed no later than the fifth year after the year of death. Distributions before then are optional.

If the participant died on or after the RBD, distributions must be made over the remaining single life expectancy of the IRA owner. More than the RMD for a year can be taken at any time.

The Secure Act of 2019 did not change the rules for nondesignated beneficiaries. The same rules apply whether the death occurred before or after 2020.

Transfers From an Estate IRA to an IRA for an Individual

If you inherit an IRA because you are the beneficiary of an estate, your distribution options are the same as those that apply to the estate.

Example 1: Owner Dies After RBD

John Smith died in 2022 at age 75, leaving a $1 million traditional IRA. His estate is the named beneficiary of his IRA. The beneficiary of John’s estate is his 55-year-old son, Larry.

Since John died after his RBD, the estate may take annual distributions based on John’s remaining life expectancy of 13.8 years.

Distributions from the estate’s beneficiary IRA must be reported under the estate’s tax identification number on Forms 1099-R issued to the estate.

Larry doesn’t want to keep the estate open for 13.8 years. Following his CPA’s advice, he asks the custodian to transfer the IRA to a beneficiary IRA in Larry’s name in 2023.* As a result of this transfer, the 1099-Rs will be issued to Larry under his own Social Security number. However, the distribution option is still based on the estate being the beneficiary, not John.

*Some custodians will accommodate such transfers. Others will not unless the beneficiary obtains IRS approval via a Private Letter Ruling. Always check with your IRA custodian regarding their policies.

Example 2: Owner Dies Before RBD

Now, assume John dies in 2022 at age 70, which would be before his RBD. In that case, the five-year rule applies. The IRA must be fully distributed by Dec. 31, 2027. Any remaining balance after that date would be considered an RMD shortfall and subject to a 25% excise tax.

Larry Must Track the History of the Inherited IRA

Because the inherited IRA is now in Larry’s name and uses his Social Security number, there is a risk that a custodian or tax professional may mistakenly apply the rules for a designated beneficiary.

For example:

• Larry transfers the beneficiary IRA to a new custodian and hires a new CPA.
• Because Larry’s name is included in the registration and his Social Security number is used for the account, the new custodian assumes that Larry inherited it directly from John and calculates the RMD based on Larry’s age.
• The new CPA audits the RMD calculation but makes the same assumption and approves the calculation.

The Risk

If John died before his RBD, the CPA would think that John had 10 years to distribute the IRA instead of five, causing Larry to have an RMD shortfall after the fifth year. Any amount not withdrawn by the end of 2027 would be subject to a 25% excise tax.

If John died on or after his RBD, the CPA might mistakenly think the IRA must be emptied within 10 years instead of over John’s 13.8-year remaining life expectancy. This could cause Larry to withdraw the account over a shorter period than required.

Pro Tip: An inherited IRA must be registered in the decedent’s and beneficiary’s names. Larry should keep the estate’s name after the transfer to his beneficiary IRA and add his name. This will alert interested parties to the fact that the estate was the beneficiary at the time of John’s death.

Who Is Responsible for Calculating RMDs?

Larry is responsible for calculating his RMD. He should seek the assistance of his tax advisor or CPA when doing so.

Who Is Responsible for the Excise Tax?

Ultimately, Larry is responsible for paying the excise tax to the IRS. However, there are two things to consider here:

1. If Larry corrects the shortfall during the correction window (see Page 9 of the Form 5329 instructions), the excise tax is reduced to 10%.
2. Larry may request a waiver of the excise tax based on these circumstances, which the IRS would likely consider reasonable cause. Larry should seek the help of his CPA to request the waiver.

The excise tax is reported on IRS Form 5329, which is available at the IRS website.

Should You Name Your Estate as the Beneficiary of Your IRA?

The answer depends on your estate-planning objectives. Here are some factors to consider:

If you die before your RBD, the five-year rule applies. But if you name a person as the beneficiary, they will have 10 years to distribute the asset, allowing for more-efficient tax-planning opportunities. For a Roth IRA, the account could grow tax-free for 10 years. If your beneficiary is an eligible designated beneficiary, they would also have the option of distributing distributions over their full life expectancy, limited to 31 years for your minor child.

If you die after your RBD, distributions may be stretched over your remaining life expectancy. However, if you name a person as your beneficiary, they would have 10 years to distribute the account and must take annual RMDs. If they qualify as eligible designated beneficiaries, they must take distributions over their full life expectancy, with your minor child being limited to 31 years.

Consider, too, that some IRA custodians will not allow a transfer of assets from an estate to the beneficiary of the estate unless the beneficiary obtains approval from the IRS under a private letter ruling. PLRs incur an IRS fee as well as professional fees.