How Does an Estate Treat an IRA?

By Mark Kennan

An IRA is a unique creature when it comes to an estate inheriting the IRA or having to pass it along to beneficiaries. If the IRA names a beneficiary, the estate can simply pass along ownership of the account. However, if the decedent didn't name a beneficiary, the tax rules are more complicated.

Minimum Distribution

When a decedent dies, the estate is responsible for making sure the decedent's last required minimum distribution is taken, if needed. If the decedent would have turned 70½ years old or older in the year of death, the decedent is required to take a required minimum distribution for the year. If the taxpayer did not do it by the end of the year, the estate must take it on behalf of the decedent.

Estate as the Beneficiary

If the IRA does not list a beneficiary, the estate is treated as the beneficiary. As the beneficiary, the estate has its own set of required distributions. If the decedent died before having to take required minimum distributions, the estate must distribute the entire amount from the IRA by the end of the fifth year after the decedent's death, but no distributions are required before then. If the decedent was 70½ years old or older, the estate must take annual distributions equal to the IRA value divided by the decedent's life expectancy as determined by his age in the year of death minus one for each year after the death.

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Tax Reporting

When the estate receives distributions from the IRA, the distributions are included in the estate's income for the year to the same extent that the distributions would have been included in the decedent's income. Generally, the entire amount distributed from the traditional IRA is taxable, but if the decedent had made nondeductible contributions, a portion of the distribution equal to the portion of nondeductible contributions in the IRA is excluded from income. For example, if the basis in the IRA is 35 percent of the total value at the time of the distribution, 35 percent of the distribution will be tax-free. If the estate then distributes the IRA withdrawals to the heirs, the estate can deduct the distributions from its taxable income and the beneficiaries must then include it in their income.

Penalties

Failing to take the required distribution results in a 50 percent penalty. For example, if the estate was supposed to withdraw $30,000 by the end of the year but only took out $5,000, the estate would owe a $12,500 penalty because it failed to take out $25,000. If the estate's failure to take a required distribution is due to a good faith error, such as an error by the financial institution, the estate can request a waiver of the penalty if it is taking steps to correct, or has already corrected, the error.

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References

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