How An IRA Is Treated When A Beneficiary Dies

When an IRA owner dies while the IRA still has funds in it, the primary beneficiary(ies) have the opportunity to transfer the account to an inherited IRA and begin taking the Required Minimum Distributions (RMDs) over his or her lifetime. When this primary beneficiary dies, it can be difficult to figure out who the money goes to. This is known as the successor beneficiary.

It’s important to know the difference between a successor beneficiary and a contingent beneficiary. A contingent beneficiary takes the place of the primary beneficiary in the event that the primary beneficiary dies before the original owner does. A successor, on the other hand, takes the place of the primary beneficiary when the primary beneficiary outlives the original owner. So it’s a matter of timing. What we’re interested in is the successor beneficiary.

There are four main ways that a successor beneficiary is determined:

  • Successor is named by the primary beneficiary. When the inherited IRA is established, the primary beneficiary has the opportunity to name one or more beneficiaries of the inherited IRA, along with contingent beneficiaries if desired.
  • Successor is the primary beneficiary’s estate. If the primary beneficiary hasn’t designated a beneficiary of the inherited IRA, the primary beneficiary’s estate becomes the successor beneficiary of the IRA.
  • Custodial documents name a successor beneficiary. Some IRA custodians provide for the designation of a successor beneficiary in the original plan documents. This is relatively rare, and even more rare that a successor is actually named.
  • Original owner names a successor beneficiary. Sometimes the original owner has had the foresight to utilize a trust document of some variety to control succession among beneficiaries. In a case like this, the trust is the primary beneficiary, and the trust has a primary beneficiary and successor beneficiary(ies).

Distribution for the Successor Beneficiary

So, having sorted out that we are working with the appropriate successor beneficiary, we need to determine what is the proper distribution period for the successor beneficiary. As we know, if the IRA is an inherited IRA, it is subject to Required Minimum Distributions, over a period determined by the beneficiary’s age at the time of the death of the original owner. This figure is determined from Table I in the first year of distribution (the year after the death of the original owner), and is a set period of time. The factor from Table I is used in the first year, and each subsequent year one is subtracted from the first factor and the IRA is distributed based on that amount.

So, for example, if the beneficiary is 71 years of age in the first year of distribution, according to Table I the factor is 16.3. The IRA value is divided by 16.3 to come up with the RMD for the first year. Each subsequent year 1 is subtracted from the Table I factor, so that the IRA is distributed over 16.3 years. This is known as the Applicable Distribution Period, or ADP.

When a successor beneficiary takes over to receive distributions from the inherited IRA, the original ADP is still in effect, and the IRA must be distributed over that remaining period to the successor beneficiary(ies).

Complications

Several factors can add a considerable degree of complication to the process – such as if there are multiple primary beneficiaries and/or multiple successor beneficiaries.

Each primary beneficiary is treated separately, and the successors for each (unless determined by the original plan as mentioned above) are determined by the individual beneficiary. When there are multiple successors, each one is treated separately and the original ADP for the applicable primary beneficiary applies to all successors pro rata for the successor’s share.

Another complication is when one or more beneficiaries disclaims the inheritance. In a case like that, first it is determined whether the original beneficiary designation had pre-determined the successor for each primary beneficiary (such as “per stirpes”, meaning that the heirs of the original beneficiary are bequeathed the disclaimed share). In the absence of this sort of designation, the other beneficiaries in the primary class take over the disclaimed share.

Of course in the real world there are many, many more complications, but this should give you a place to start. Use the comments section below to bring in your more complex situations and we’ll work them out.

About the author

Jim Blankenship, CFP®, EA

Jim Blankenship is the founder and principal of Blankenship Financial Planning, Ltd., a financial planning firm providing hourly, as-needed financial planning and advice. A financial services professional for over 25 years, Jim is a CFP professional and has earned the Enrolled Agent designation, a designation that qualifies him as enrolled to practice before the IRS. Jim is also a NAPFA-registered financial advisor, which designates him as a Fee-Only Financial Advisor.

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16 Comments

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  • Nice article. What happens if the primary beneficiary dies? The owner of the IRA outlived the benficiary but did not change the benificiary. Does it go to the spouse or the estate?

    • If there is no living primary or successor beneficiary, the law of the state will apply. This generally means that the account would become the property of the estate – but check with your state intestate laws to be sure about it.

  • If the named beneficiary of an IRA dies before the owner of the IRA does the IRA go back to the owners estate or the deceased beneficiary’s estate?
    And can the IRA be received by a lump sum distribution?

    • I believe if the original owner has not designated a successor or secondary beneficiary, the IRA would go to the original owner’s estate. With no other beneficiary designations, the IRA would have to be paid out to the estate within 5 years of the death of the original owner.

  • I have a client who is the IRA owner of an inherited IRA. She inherited the IRA from her father who died at age 80. She is currently receiving payments over her lifetime. I understand that it is a matter of state law if she can name beneficiaries of this inherited IRA – we are located in Indiana and I cannot find anything in Indiana law that allows or does not allow her to name beneficiaries.

    Can you point me in the right direction?

  • JIM, If the successor beneficiary dies (survived by his wife) before naming a beneficiary and his estate becomes owner, does this eliminate the stretch option for his widow ? A quick reply is appreciated.

    • I believe the wife of the successor beneficiary would simply continue the RMDs as if they were being paid out based on the life of the original beneficiary. In other words, this successor to the successor just assumes the role of the first successor.

      You’ll probably want to get a legal opinion on this, the foregoing is an educated guess, and state law may affect the actual outcome.

  • Wanted to get your take on this situation.

    My father passed away Feb. 28, 2015
    My sister passed away June 29,2015.
    There are three children.

    We three children are beneficiaries of my dads IRA.

    My sister who passed had assigned me and my other sister as her beneficiaries to avoid going through her estate. My mother left my father for another man and my father and my sister do not want her to get any of that money, that is why my sister assigned myself and other sister as beneficiaries.

    Our attorney and financial planner are saying that since my sister’s inherited IRA hasn’t “funded” yet, that it will most likely have to go through her estate. We are not sure what has taken so long, that is a question for the financial planner.

    We do not want this to go through her estate.

    Any thoughts?

    Thanks in advance.

  • Great article Jim. How many subsequent generations can the IRA be stretched? i.e. does the successor beneficiary have an opportunity to name a beneficiary and pass along the assets accordingly?

    My other question is what if the beneficiary inherits an IRA where the owner wasn’t yet required to take RMDs?

    • This depends on several things. First of all, if there was a contingent beneficiary named in the plan documents, if the primary beneficiary pre-deceases the plan participant, the contingent beneficiary would receive the proceeds of the plan.

      If there is no contingent beneficiary and the primary beneficiary pre-deceases the plan participant, the plan documents (i.e., the “fine print”) should define who is the default beneficiary. This could be very vague, such as “all living heirs”. Or, the plan documents may not name a default beneficiary, in which case the estate of the plan participant would be the default by testate law.

      If the primary beneficiary is one of several primary beneficiaries named, it can be even more complicated, and you’ll want to enlist an estate attorney to help sort things out.

      Hope this helps –

      jb

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