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Inherited IRA can pack a tax bite if annual distributions are delayed

An IRA must make taxable annual distributions after

An IRA must make taxable annual distributions after its owner's death. Credit: iStock

How can I leave an IRA to several grandchildren with the stipulation that they not receive the inheritance until age 30?

You could leave it to a trust for their benefit that pays them nothing until they turn 30. But it makes more financial sense for them to receive IRA distributions every year.

Here's why: After your death, your IRA beneficiary must take taxable required minimum distributions (RMDs) from the account based on his or her life expectancy. Beneficiaries can withdraw more than the annual RMD — but never less. Meanwhile, what stays in the IRA keeps growing untaxed.

If your IRA beneficiary is a trust, the annual RMDs can be based on the life expectancy of the oldest trust beneficiary — i.e., your oldest grandchild. If the trust promptly passes each RMD to your grandchildren, they'll share it and pay taxes on it at their own rates. But if RMDs accumulate in the trust, it pays taxes on them at its much higher rate. "The federal tax on trust income above $12,150 is 39.6 percent. With state and city taxes, the trust pays over 50 percent," says Ed Slott, a Rockville Centre tax accountant. "A couple filing jointly doesn't pay 39.6 percent in federal tax until their income is over $457,600."

Slott's advice: Let the trust pass the annual RMDs to your grandchildren. "Say it's a $1 million IRA and you have three grandchildren. The RMDs will be small. If the oldest is 20, he has a 63-year life expectancy. The first RMD would be $15,873 — less than 1.6 percent of the IRA — and it's divided between them."

If you wish, your trust can limit the circumstances under which IRA withdrawals can exceed the annual RMDs until your grandchildren are older.

The bottom line An IRA must make taxable annual distributions after its owner's death.

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