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Inherited IRA Multiple Beneficiary Example

All of the beneficiaries of the future rice mill

I thought it might be helpful to work through an example of an IRA that has been inherited by multiple beneficiaries, so that we can discuss the important components of working with such a situation.

In our example, we’ll say there is an IRA worth $800,000 at the date of death of the original owner, and she has designated four beneficiaries of the account.  One of the first factors that is important to note is that the beneficiaries could be anyone – they do not have to be related to the original owner, or likewise they could be the children, grandchildren, nieces, nephews, brothers or sisters of the original owner.  For the purpose of this example though, none of the beneficiaries is the surviving spouse of the original owner – surviving spouses have different rules to work from.

Option 1 – Do Nothing

The beneficiaries of the original account could choose to make no changes to the account, leaving it exactly where is was during the life of the original owner. Assuming that the original owner was not subject to Required Minimum Distributions (that is to say, the original owner was not age 70½ or older), the account will be distributed over the lifetime of the oldest of all the beneficiaries, in equal shares to each of the four.  Table I, Single Life Expectancy, is used to determine the amount of the distribution, and the age is the age of the oldest beneficiary. (If the original owner was subject to RMD, the beneficiaries have the option of using her lifespan instead of the lifespan of the oldest beneficiary if this would result in a longer payout period.)

This option results in the least amount of “moving parts” and is likely the simplest to implement, but as we all know, getting four people to agree on things like how to manage the account, what investments to make, etc., is a difficult task.  This option also requires the younger beneficiaries to take distributions of larger amounts than would be required if the account were distributed over their own, longer, life span.

Option 2 – Separate Accounts

The beneficiaries of the IRA account have the option of splitting up the account into equal shares of the original account.  In this fashion, each individual would own an account, titled as “inherited” so that there’s no misunderstanding – the account is inherited, not a regular IRA (more on this later).

Once the separate accounts are set up, each of the four beneficiaries is allowed to (actually required to) take distributions over his or her own lifespan, rather than all being required to take distributions over the oldest beneficiary’s lifespan as was the case in Option 1.  In addition, each beneficiary can now make the investment and management decisions about the account separately.  The individual beneficiary should now also designate a beneficiary for any amount that is remaining in the account when the individual beneficiary dies.

Important Points

A few points that are very important to note here:

  • The separate accounts are the property of each individual beneficiary, but the account must retain a title which clearly designates the account as inherited.  Since the account is inherited, the owner of the account cannot make contributions to the account, roll it over into another IRA account, or convert the account to a Roth IRA.
  • When creating the separate accounts, it is important to ensure that the transfer is a trustee-to-trustee transfer.  If the funds are removed from the account (as in a 60-day transfer) then contribution back into an IRA is not allowed, and the amount distributed is no longer considered to be an IRA.
  • The separate accounts must be established by December 31 of the year following the year of the death of the original owner.  If not established by this date, then Option 1 is the default, and now only, option available.
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  1. Thad Hunkins says:

    Ok, once I’ve set up the inheritance IRAs for the beneficiaries (in this case, from a Trust) with the Trust-designated proportions and they “own” them, will they be penalized 10% for liquidating if they are less than 591/2 years of age? Very important question for the 20-something Grandkids. And for the 12-year old Grandkid, I assume that the IRA stands in her Custodial Trust until she comes of age?

    This was an excellent article. Thank you, Thad

    1. jblankenship says:

      IRA beneficiaries are not subject to the 10% early withdrawal penalty regardless of age – they are required to take distributions from the inherited IRA.

      Likewise, even a minor child is required to take distributions from the inherited IRA. There is no holding the IRA until the age of majority, a minor’s guardian or representative typically handles whatever distributions are needed until the child is of age.

      Bear in mind, that article is 10 years old, and the rules for inherited IRAs, specifically how distributions work, have changed. See the article Inherited IRAs After the Secure Act for more details.

      In addition, the interpretation of those rules is undergoing adjustment as well. It is expected that the IRS guidance will indicate that non-Eligible Designated Beneficiaries will be required to take a withdrawal each year during the 10-year period after the death of the original IRA owner, rather than only being required to liquidate by the 10th year. This is still in development.

  2. Shruti Bansal says:

    What if the original owner was 85 and taking RMDs. Then if 4 beneficiaries inherit the IRA, are they all required to take the distributions based on original owner’s RMD schedule or it switches to their own single life expectancy (assuming they split the inherited IRA into 4)

    1. jblankenship says:

      It would work that way if the beneficiaries were eligible designated beneficiaries. Otherwise they’d be using the 10-year distribution period, as all non-eligible designated beneficiaries do.

  3. derek d says:

    On Dec 2, 2011 you wrote: This is How You Convert An Inherited 401(k) to a Roth IRA” for FiGuide.

    I’m confused. In this article you state: “Since the account is inherited, the owner of the account cannot make contributions to the account, roll it over into another IRA account, or convert the account to a Roth IRA.”

    Is this because one deals with inheriting a 401(k) and the other deals with inheriting an IRA?

    Ultimately, the question is how does a 401(k) beneficiary get the inherited money in to a Roth IRA?


    1. jblankenship says:

      That’s exactly the point, Derek. The option to convert the account to Roth is ONLY available for an inherited 401(k) (or other QRP, like a 403(b)) but not for an inherited IRA.

      If the inherited account is a 401(k), the beneficiary can convert the funds to a Roth IRA account, paying tax on the conversion. Then there will still be Required Minimum Distributions on the Roth IRA account, but all of the tax has been paid up-front.

      Hope this helps –


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