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Stretching an IRA When There Are Non-Individual Beneficiaries

Ira and Charlie

Ira and Charlie (Photo credit: Wikipedia)

As we’ve discussed here previously, one of the requirements to enable an inherited IRA to be “stretched” over the lives of the beneficiaries is that all of the beneficiaries must be individuals.  That is to say, none of the beneficiaries can be something other than a person, such as a trust (specifically a trust that is not a see-through trust), a charity, or an estate.  If even one beneficiary is not a person, then all of the beneficiaries must take distribution within five years.

But there’s a way around this, and it has to do with the timing of distributions.

When an IRA owner dies, there is a key date to know: September 30 of the year following the year of death of the owner.  On that date, the beneficiaries are “set” for the IRA, and if available, the Designated Beneficiary is named.  It is on this date that the applicable distribution period is defined for the beneficiaries of the IRA.  If all of the beneficiaries are persons (not some other entity as described above) and the IRA is not split into separate inherited IRAs for each beneficiary, the oldest beneficiary becomes the Designated Beneficiary.  It is the lifetime of the Designated Beneficiary which will determine the applicable distribution period for all beneficiaries.  However, if the IRA is split up into separate inherited IRAs for each beneficiary, then all beneficiaries are Designated Beneficiaries, and each separate inherited IRA’s beneficiary will be eligible to use the distribution period referencing his or her own age.

However – as mentioned above, if one or more beneficiary(ies) on September 30 of the year following the year of death of the original owner is a non-person entity, then all beneficiaries must take distribution of their portion of the IRA within 5 years.  The date is the key: if distribution of the non-person entity’s portion is completed prior to September 30 of the year following the hear of the death of the original owner, then as of that date there would be only “person” beneficiaries.  This would allow for the remaining individuals to split up the IRA into separate inherited IRAs and take distribution over their individual lifetimes, per the IRS’ tables.

For example…

John died at the age of 68 in June of 2012, leaving his IRA and other assets primarily to his two children, Chuck and Sally.  However, he also wanted to make sure that his alma mater, Enormous State University, received 1/3 of his IRA, worth $1 million at his death.

If John’s executor does nothing with the IRA assets prior to September 30, 2013, Chuck, Sally, and ESU will have to take distribution of $333,333 each before the end of 2018.  This could amount to a considerable tax burden for Chuck and Sally (ESU wouldn’t have to pay taxes as an educational institution), since each would have to withdraw as much as $66,667 each of the five years. It should be noted that the distribution doesn’t have to be evenly split over the five years as long as the account is fully distributed by the end of five years.

On the other hand, if John’s executor were to distribute the 1/3 share to ESU before September 30, 2013, then ESU is no longer a beneficiary of the IRA on the Beneficiary Designation Date.  With that fact in place, the IRA has only “individual” beneficiaries, and so the account can be split evenly between inherited IRAs for Chuck and Sally, and then Chuck and Sally can stretch the IRA distributions over their own lifetimes. per the IRS tables.

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  1. FBN says:

    My understanding is that if a trust is named as beneficiary and it has provisions as a look through trust then the stretch can still be done using the RMD calculation for the oldest beneficiary.

    1. jblankenship says:

      That is true unless any of the beneficiaries is not a “natural person”, as outlined in the article.

      1. FBN says:

        Thanks for clarification. My biggest problem with executing the stretch for my father’s IRA was getting the custodian, TD Ameritrade, to agree. I met all the requirements but they still refused to cooperate. I had to transfer to Fidelity as custodian where they understood the rules and were easy to work with.

  2. clydewolf says:

    Good points!

    John’s executor needs to provide the IRA Custodian with the required papers. Then the IRA Custodian would contact the beneficiaries. It wold seem practical at that point the 2 children would want their own beneficial IRA to allow for the stretching. Probably ESU would want a lump sum distribution.

    My point is it is the IRA custodian that distributes the IRA, not John’s executor.

    1. jblankenship says:

      Excellent point as usual, Clyde. I didn’t include the mechanics of the distributions, but you’re exactly right: you have to make sure that the custodian is willing to make the distributions as you hope in order to get this all to happen.



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