A client, “Susan,” contacted me recently to help settle the affairs of her recently deceased son, “Frank.” Frank owned a traditional IRA that has a fairly substantial balance. Unfortunately, Frank did not list a beneficiary for the account. Shelly is Frank’s only living heir. Frank was 57 when he died in 2018. What are Susan’s options with regard to Frank’s IRA?
Because Frank’s IRA had no identifiable beneficiary, by default the IRA is payable to his estate. And since Frank died before age 70½, a special 5-year rule applies to the distribution of his IRA. In general, the entire balance of Frank’s IRA must be distributed by December 31 of the year containing the fifth anniversary of Frank’s death. In this case, the entire balance of Frank’s IRA must be distributed by December 31, 2023.
An estate does not have a life expectancy, so distributions cannot be “stretched” beyond the 5 years. However, the entire account balance does not have to be taken in one distribution, it can be broken up over multiple years to reduce the taxes payable as long as the entire account balance is distributed before the end of the fifth year following the year of the account owner’s death.
(Now, had Frank died after April 1 following the year he attained the age of 70½, Susan would have been able to stretch distributions from Frank’s IRA to the estate over his remaining life expectancy, avoiding the special 5-year distribution rule.)
If the entire account balance is not withdrawn by the end of the fifth year following Frank’s death, then the IRS could impose a penalty equal to 50% of the balance remaining. The penalty could be waived by the IRS if it finds there was a reasonable basis for the error.
Failing to designate a beneficiary of an IRA (or other retirement account for that matter) is one of the costliest mistakes you can make. Two problems are created: First, because distributions cannot be “stretched” beyond 5 years, there is little tax-deferred growth that can be achieved in such a short period of time. Second, since distributions from the account must be accelerated, the larger distributions create larger income tax bills.
It always pays to double check beneficiary designations on your retirement accounts (and life insurance, too). I recommend at least annually. Make sure you have beneficiaries named on all of your accounts, and to make sure those beneficiary designations are up to date. Has a beneficiary died, or is there some other reason to replace a beneficiary? If so, update your beneficiary designations immediately.
Do you have an issue concerning distributions from a retirement account, or planning for distributions from a retirement account? If so, call me, I can help.