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.

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.

  • Gary

    In either situation (death before or after the RBD) is it correct that the distributions MUST come out to the Estate over the appropriate period and will be taxed (annually)as income TO the estate, AT Estate rates, thereby necessitating that the Estate remain open for the entire time over which the distributions are to be made? Asked another way: Can an IRA where the estate is the beneficiary at the time of death ever be transferred to the estate heirs via individual IRA Beneficiary Distribution Accounts?

    • bobrichards

      If the designated beneficiary is the estate (explicity or by default), I know of no way that can be chnaged unless some lawyer can show incompetency or mistake or find some other leagl loophole.

      • Gary

        Thank you.

  • danny

    my father’s ira was paid to his estate account to be distributed between my brother and me—who pays income tax on this amount (it is only total-$38000)—if the estate pays tax are my brother and i taxed addtionally?

    • bobrichards

      your brother and you pay the income tax

  • art nuvo

    In New Jersey if the estate is named as the beneficiary of a traditional IRA and there is a pourover will that pours over all assets not in a revocable living trust to the trust, does it follow that the beneficiaries of the IRA are determined by the distribution formula in the living trust?

    • bobrichards

      Dont know. each state has its own rules. You are also confusing state and federal tax issues on the same question.