An individual retirement account or “IRA” is a tax-advantaged account that people can use to save and invest for retirement. Some people have come to our attorneys at Beck, Lenox & Stolzer Estate Planning and Elder Law, LLC, LLC to ask the question, Should I make my estate my IRA’s beneficiary? There are important tax consequences that may result from doing that, according to nj.com’s recent article entitled “How is tax paid when an estate is the beneficiary of an IRA?”
If an estate is named the beneficiary of an IRA, or if there’s no designated beneficiary, the estate is usually designated beneficiary by default. In that case, the IRA must be paid to the estate. As a result, the account owner’s will or the state law (if there was no will and the owner died intestate) would determine who’d inherit the IRA.
There are several types of IRAs—Traditional IRAs, Roth IRAs, SEP IRAs and SIMPLE IRAs. Each one of these has its own distinct rules regarding eligibility, taxation and withdrawals. However, with any, if you withdraw money from an IRA before age 59½, you’re usually subject to an early-withdrawal penalty of 10%.
A designated beneficiary is an individual who inherits the balance of an individual retirement account (IRA) after the death of the asset’s owner.
However, if a “non-individual” is the beneficiary of an IRA, the funds must be distributed within five years, if the account owner died before his/her required beginning date for distributions, changed to age 72 last year when Congress passed the SECURE Act.
If the owner dies after his/her required beginning date, the account must then be distributed over his/her remaining single life expectancy.
The income tax on these distributions is payable by the estate. A compressed tax bracket is used.
As such, the highest tax rate of 37% is paid on this income when total income of the estate reaches $12,950. Remember, this income limit affects non-individuals, such as estates.
For individuals, the 37% tax bracket isn’t reached until income is above $518,400 or $622,050 if filing as married.
Based upon the above tax treatment, you can see why it’s not wise to leave your IRA to your estate. It’s not tax-efficient and generally should be avoided. However, if you are thinking “yes” to the question, “Should I make my estate my IRA’s beneficiary”, let the experienced estate planning attorneys at Beck, Lenox & Stolzer help you evaluate that decision.
Reference: nj.com (Feb. 26, 2021) “How is tax paid when an estate is the beneficiary of an IRA?”