If you're in line to inherit an IRA from a spouse or other relative but don't need the money and want to pass it on to the existing contingent beneficiaries (the beneficiaries of the original contract owner), a recent IRS revenue ruling may now make it easier for you to do so. Here are the essentials of this new ruling and how it can affect your planning if you choose to disclaim – or give up – an inherited IRA.
Generally, there are two situations in which people can benefit from disclaiming inherited IRAs:
A recent IRS revenue ruling clarified rules for disclaiming inherited IRAs for beneficiaries who inherit an IRA from a decedent who is subject to minimum distribution rules (i.e., the decedent was age 70½ or older at the time of death and was thus required by the IRS to begin receiving a minimum amount of money from his or her IRAs). According to the new ruling, the beneficiary who inherits an IRA can disclaim it even after taking a required minimum distribution for the year of the IRA owner's death.
First, some background on required minimum distribution rules for IRAs. A spousal beneficiary for an IRA must begin receiving money from the inherited IRA by the later of the December 31 of the year after the year in which the participant died, or the December 31 of the year in which the participant would have reached age 70½. Nonspouse beneficiaries must begin receiving distributions by the December 31 following the year of the person's death.
For either spouse or nonspouse beneficiaries, if the deceased person's required minimum distribution due for the year of death was not distributed prior to death, then the beneficiary must take the year-of-death required minimum distribution by the December 31 of that year. Beneficiaries who fail to make this withdrawal will be subject to a 50% IRS penalty on the amount that should have been withdrawn.
John Smith has an IRA worth $600,000. His wife Mary is listed as the primary beneficiary and his daughter Joan as the contingent (second) beneficiary. John was 82 years old when he died in March 2006. He was required to take a required minimum distribution during 2006.
As the spousal beneficiary, John's wife Mary is responsible for completing the required minimum distribution due for 2006, which is the year of John's death. Under the new ruling, she can take his 2006 required minimum distribution and still be eligible to disclaim the IRA.
The IRS ruling can also affect the strategies investors use for stretch IRAs, which are arrangements that can enable an investor to "stretch" the period of tax-deferred earnings of IRA assets beyond his or her lifetime, typically over multiple generations. To determine the income stream that the beneficiaries may potentially receive, the IRS uses mortality tables based on the life expectancies of the beneficiaries. While stretch IRAs can be an effective way to leave funds to multiple generations of beneficiaries, the ultimate amount the beneficiaries will receive largely depends on the rate of return of the underlying investment and how long the money remains invested.
If the primary beneficiary disclaims an IRA, then the inheritance will pass to the "next-in-line" beneficiary or the contingent beneficiary. The primary beneficiary can disclaim all or partial amounts of the IRA; this rule allows people who need some of the IRA funds – but not all of them – to obtain the money they need and leave the remainder to their own beneficiaries.
For instance, a primary beneficiary can disclaim 50% of an inherited IRA worth $600,000; in this case, the primary beneficiary keeps $300,000 of the IRA while the remaining $300,000 passes on to the contingent beneficiary.
In the example described above, Mary Smith wants to disclaim half of the $600,000 IRA she inherited from her husband John. Under the rules, Mary can disclaim 50% of the IRA ($300,000). For the $300,000 she inherits, she will continue to make required minimum distribution payments for her life expectancy. Her daughter, Joan, will inherit a $300,000 IRA and can stretch the required minimum distributions over her life expectancy.
Note: The rules regarding IRAs can be complex, so you should consult an attorney and tax specialist before taking any actions.
The tax information contained herein is not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding tax penalties that may be imposed on the taxpayer. TIAA-CREF or its affiliates do not provide tax or legal advice. Taxpayers should seek advice based on their own particular circumstances from an independent tax or legal advisor.
The material is for informational purposes only and should not be regarded as a recommendation or an offer to buy or sell any product or service to which this information may relate. Certain products and services may not be available to all entities or persons.
TIAA-CREF Individual & Institutional Services, LLC and Teachers Personal Investors Services, Inc., distribute securities products.
There are benefits to an IRA rollover.