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Beneficiary IRAs and Your Financial Plan

Beneficiary IRAs and Your Financial Plan

June 13, 2021

What is a Beneficiary IRA?



Hi everyone, and welcome back to Melissa Making Cents!

As a CERTIFIED FINANCIAL PLANNER™ and a financial coach, I understand that there are many instances in life that are… out of our control. These can vary in severity from your child choosing a more expensive college than you were planning on to more serious things. While it's not happy or cheery to talk about, lifespan is one of those things that's more or less out of our control. Death and loved ones passing on are some of the more difficult things that anyone in any profession has to deal with. My profession is no exception. Unfortunately, death happens, and more, unfortunately, there are serious monetary considerations that come with a loved one passing on. 

I want to pause here for just a second and reiterate how difficult losing a loved one can be. While finances are essential, and can certainly be an additional hardship to all those involved, what's perhaps most important is taking care of your own physical and mental health. I, like many of you have or will eventually have, have dealt with the loss of loved ones and loved ones who've lost loved ones. Keeping a healthy support system in the wake of a tragedy can make a huge difference in how you grieve and your wellbeing. Having proper resources to deal with such loss can also make a significant difference. While I can't help you build your support system, other than general advice, I can take a moment to link to a few resources that may help you if you find yourself in this unenviable position. The American Counseling Association has put together an incredible bundle of links, resources, articles, and support groups that you can find here

Now… back to the blog post. Wills, bank accounts, and funeral expenses are just a few of the very serious familial financial issues that will come up in the wake of a loved one's death. While much of this (hopefully) is clearly defined and cookie-cutter, there are exceptions. One of the often more confusing issues that may arise in these circumstances is IRAs. Now, you may be thinking, "Melissa, we're talking about post mortem finances… what on EARTH does that have to do with IRAs?". The answer to that is… quite a bit, actually. Throughout this post, we'll be discussing what Beneficiary IRAs, or Inherited IRAs, are as well as the different rules and regulations that come with them. These rules can vary depending on a multitude of factors, like your relationship to the deceased, if the deceased left their IRA to a person or an entity, and the differences between the old rules and the new rules that began in 2020. 

What IS a Beneficiary IRA or an Inherited IRA?

Melissa Cox CFP describes a Beneficiary IRA

Let's start off by defining a few terms. The official term is an Inherited IRA; however, these are commonly referred to as Beneficiary IRAs. For the purposes of this article, I may use those two terms interchangeably, but I'll try my best to stick to saying Beneficiary IRA from here on (however, remember that they're the same thing). An IRA, or an Individual Retirement Account, is essentially an account that you can put many things in, including stocks, bonds, real estate, and other investments. IRAs were created by the government as a way to incentivize saving for retirement age. If you're interested in learning more about IRAs in general, I've written a blog post that goes over them in quite a bit of detail, How IRAs Could Fit Into Your Financial Plan.

When you create an IRA, you name a beneficiary or an entity to gain ownership of the account in the event of your death. Once you inherit an IRA, you actually have to open up an IRA of your own to access the IRA's assets. Once the original IRA's assets have been successfully transferred to the new IRA, you've created your Inherited or Beneficiary IRA (last time, these are the same). A Beneficiary IRA comes with its own set of rules for withdrawing money. These rules can be pretty complicated, and they change depending on your relationship to the original account owner and some other details, which we'll get into a little later on. Because these rules are complicated, entire businesses and branches of companies are dedicated to resolving, supporting, and helping inheritors.

Beneficiary IRAs are different for Spouses and Non-Spouses

Melissa Cox CFP explains the difference between Beneficiary IRAs for Spouses and Non-Spouses

As I stated above, there are different rules for spouses and non-spouses when dealing with a Beneficiary IRA. Specifically, there are rules about how you can and can't withdraw from the IRA and how to form the Beneficiary IRA. 

  • Spouses: Spouse Dies Before Required Beginning Date

As a spouse, you have a lot of options that you wouldn't have otherwise. There are several ways that you can go about taking on the Beneficiary IRA. If your spouse died before their Required Beginning Date*, the most common practice is to take the IRA in your own name. This is the most tax-efficient method for inheritors. Retitling as a spouse comes with the benefit of not paying required minimum distributions until you reach the age of 72. 

You also have the option to follow the five-year rule. This allows you to essentially ignore the IRA for up to five years. However, at the end of that period, you're required to draw everything from the IRA. While this may sound nice at first, you'll be on the line for the taxes that are owed on the assets in the IRA when you withdraw.

  • Spouses: Spouse Dies After Required Beginning Date

If your spouse dies after their required beginning date, you can once again retitle the account. However, this comes with a few more stipulations. You'll need to take your spouse's minimum distribution for the year of death before you can retitle. Once this is done, if you're under the age of seventy-two, you can wait until your required beginning date to begin re-taking required minimum distributions. If you're over seventy-two, you'll need to continue taking required minimum distributions each year before December 31st.  

  • Non-Spouses

Not being the spouse of the deceased, you have fewer options when inheriting an IRA. As a non-spouse beneficiary you will be required to create a new IRA. You won't be allowed to transfer the assets into an existing IRA, nor will you be permitted to add any additional contributions to the Beneficiary IRA. Per the change in IRA rules you'll also be required to completely drain the account of all assets within ten years (in most cases). However, you won't be held to required minimum distributions or penalized for early withdrawal. 

As a beneficiary you decide how to take out the assets. Some individuals opt to take all assets as a lump sum. While this might sound like a huge payday, it also comes with significant tax responsibilities. AKA, you'll be responsible for the entirety of the taxes owed on the assets that you withdraw.  As a CERTIFIED FINANCIAL PLANNER™ I always suggest contacting your tax advisor to determine how the taxes from your Inherited IRA will affect you. 

*Required Beginning Date: The required beginning date of an IRA is the date at which you'll be required to begin taking required minimum distributions. The new required beginning date is when the account holder turns seventy-two. 

**Required Minimum Distributions: Required Minimum Distributions are a calculated amount that you must withdraw from your IRA each year by December 31st. I recently wrote a post about required minimum distributions that goes into quite a bit of detail, which you can find here

Beneficiary IRAs If the Inheritor Isn't a Person

Melissa Cox CFP explains that IRAs may be inherited by entities such as schools or charities.

I hear you already. "Not a person? Melissa, are you off your rocker?". At first, it might seem a little coo-coo, but people leave entities as their beneficiaries all the time. Some instances in which the Beneficiary to an IRA might not be a person are if the IRA was left to a church, a charity, an estate, or a trust. Leaving your IRA to an entity like this is referred to as a Not Designated Beneficiary. Leaving your IRA to an individual is referred to as having a Designated Beneficiary. 

There are two main ways in which a Not Designated Beneficiary can inherit an IRA. Unlike a designated beneficiary, a not designated beneficiary doesn't get to choose which method they pick; the method applied depends on what age the original account holder was when they perished. If the account holder died before their required beginning date, the entity would be held to the five-year rule. This means that they'll need to take out the balance of the IRA within five years of death. If the original account holder perished after their required beginning date, they'd be subject to the payout rule. This rule means that the entity will be allowed to withdraw over the original account holder's remaining life expectancy. 

Changes to the Rules that Happened in 2020

Melissa Cox CFP explains the changes in IRA rules that happened in 2020

Through this article, you may have noticed I've referred to old rules and new rules. If you're wondering, I'm referring to the rule change that recently happened in 2020. In 2019, congress approved something called the SECURE act, or The Setting Every Community Up for Retirement Enhancement Act. While the SECURE act was far-reaching, it had some changes that affected IRAs in an attempt to help older Americans stretch out the balance of their IRAs. While I won't bore you with all of the details of the SECURE act, I will bore you with the parts that are relevant to this post and IRAs in general. 

First, the SECURE act changed the age that account holders must begin taking required minimum distributions. Before the SECURE act, that age was 70 1/2, but now it is 72. Secondly, this act made it mandatory that most non-spouses cash out their Beneficiary IRA within 10 years of the original account holder's death. 

Dealing With Loss and Planning Ahead of Time

Melissa Cox CFP explains that it is important to create a plan for your loved ones financial futures.

The fact is that there's never a good time for a tragedy to strike. I can't state enough how difficult it is to lose a loved one and how much hardship something like that brings to an individual and family. In my experience, when it comes to finances, the best route of action is to plan ahead of time. While it's a very uncomfortable truth, the reality is that we all have our expiration date. If you're reading this and have an IRA with a beneficiary, the best thing you can do for them is to go over the details of your IRA. Even though conversations like that are uncomfortable, you'll be setting them up with a plan of action in the case of your death. Because being in the wake of a death is a powerful and disorienting thing, having the security of knowing what will happen may offer them a security blanket during their grief. 

A CERTIFIED FINANCIAL PLANNER™ Can Help You and Your Loved Ones Understand IRAs

As a CERTIFIED FINANCIAL PLANNER™, Melissa Cox helps clients and their families to understand IRAs

While it's easy to think I'm only referring to Beneficiary IRAs, this advice is all-encompassing. Having a plan already set upon your death for your funeral, burial, will, and assets are something that will help your spouse and loved ones out tremendously. If you have an IRA and you're interested in discussing beneficiary options or if you don't know where to go next with a recently inherited IRA, I want to be there to help. As a CERTIFIED FINANCIAL PLANNER™ and financial representative, I can help you create a step-by-step plan of what to do next. 

It doesn't matter what stage of life you're in, if you have an IRA, or if you're just now beginning to think about retirement. Having a professional in your corner who can help you find direction is a priceless thing. If you're interested in talking or meeting to discuss your options, please, feel free to call or email to schedule an appointment with me. Together we can create a financial plan that helps you become debt-free, make a savings security blanket, and put your money to work for you!

Schedule a call with Melissa Cox CFP®

Until next time...this is Melissa Making Cents!

Melissa Anne Cox, CERTIFIED FINANCIAL PLANNER™, is also a College Planning and Student Loan Advisor and Financial Coach in Dallas, Texas.

Read last week's blog post by Melissa Cox CFP®