Ask the Expert: Tax benefits can be lost on inherited IRAs

My mother died in 2022, leaving a $15,000 individual retirement account (IRA) with no beneficiaries. My sister (the executor) closed it and moved the money to the estate’s bank account and then sent me a check for $7,500. What are my options to avoid paying taxes on it?

There are none. When your late mother’s IRA was distributed to her estate, it became taxable income to the estate beneficiaries.

Your story is a sad example of what can happen when an IRA owner dies with no designated beneficiaries on the account.

The only way to preserve your IRA’s most favorable tax and distribution options for your heirs is to list them on the IRA’s beneficiary form, says Ed Slott, a Rockville Centre tax accountant. That form always supersedes your will.

When no one is designated on the form, the estate is typically the default IRA beneficiary. The IRA money is then distributed under less favorable rules. IRA distributions are taxable and estates have a shorter mandated distribution schedule — and thus a shorter potential tax deferral — than human beneficiaries.

In the best case scenario, the executor can ask the IRA custodian to transfer the account directly into new inherited IRAs for the estate’s heirs. Using the estate’s payout schedule because it was the default beneficiary, the inherited IRAs would have to be emptied within five years if the deceased died before she was required to begin taking annual minimum distributions (RMDs), says Slott. If she died after her RMD start date, distributions could be taken over her remaining actuarial life expectancy (had she lived.)

But if the estate empties the IRA immediately, the entire amount becomes taxable.

The bottom line

A non-spouse beneficiary can temporarily preserve an IRA’s tax-protected status only by transferring it directly into an inherited IRA account.

More information

bit.ly/IRSdistributionsfromIRAs

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