Siblings who inherit an IRA have several options regarding this inheritance, including splitting it amongst themselves. The action taken by the siblings regarding the inherited IRA would depend on whether they are minors and whether they need the money immediately. It is important to discuss with your siblings what your goals are so that the appropriate action can be taken. Any action taken is irreversible and will have significant tax consequences.
First, a brief review of how an IRA works
An IRA is an individual retirement account that allows you to save money tax-free throughout the course of your life. The account holder deposits money in the IRA as savings, and these savings can earn income without paying any income tax. Thus, the money in an IRA can grow income tax-free. You cannot, however, withdraw money from an IRA before you turn 59 ½ years old without incurring a 10% penalty. This large penalty aims to encourage the IRA to be treated as a retirement savings account.
When the account holder turns 72, the account holder has to begin making withdrawals annually from IRA. The amount of withdrawal has to be a certain percentage of the account value. This is called a required minimum distribution (RMD). Withdrawals from a regular IRA are subjected to income tax. Withdrawals from a Roth IRA are not subjected to income tax because tax is imposed prior to depositing it in the IRA.
When the account holder dies, the designated beneficiary inherits the IRA directly without going through the probate process. The inherited IRA, however, will be clawed back into your estate in case your assets are not sufficient to pay for your debts or in case your surviving spouse decides to claim the elective share. No additional distributions, however, can be made to an inherited IRA, unless you are the surviving spouse who rolls over the IRA into your own IRA.
Who are eligible designated beneficiaries
Eligible designated beneficiaries are IRA beneficiaries who can disregard requirements on when the original account holder died and can follow the more preferred inherited IRA rules for account holders dying 2020 onwards. Eligible designated beneficiaries are minor children, spouse, chronically ill, disabled, or beneficiaries who are not more than 10 years younger than the account holder.
When children are designated as joint beneficiaries, they can either place the money in one inherited IRA or split it into separate inherited IRAs. Their options also depend on whether they are minors and whether they need the money immediately.
When the siblings who inherit IRA are adults
When the siblings who inherit IRA are adults, they are not considered eligible designated beneficiaries. Thus, they do not have preferred status on receiving the RMDs based on their life expectancy.
When the siblings need the money immediately
If you need the money immediately, you can get the IRA assets in a lump sump payment. Remember however that this method has tax consequences and any amount received from an IRA will be taxed as regular income tax. Thus, your tax bracket is important in determining whether you should receive the amount as a lump sum.
When the siblings do not need the money immediately
When you do not need the money immediately, you can keep the money in the inherited IRA so the money can grow income tax-free. However, all the assets in the inherited IRA have to be withdrawn within the next 10 years. For example, when the original account holder dies on April 2020, all assets in the inherited IRA must be withdrawn by December 31, 2031.
When the siblings who inherit IRA are minors
When the siblings who inherit the IRA are minors, they are considered eligible designated beneficiaries. Eligible designated beneficiaries who are not spouses are preferred and have the following options:
When the siblings need the money immediately
Any withdrawal or amount distributed and received from the IRA is taxed as regular income tax. When receiving the entire proceeds of the IRA, siblings must take into account their tax bracket. The higher the tax bracket of the sibling, the greater the income tax imposed. For this reason, if the siblings are in different tax brackets, they might want to create separate inherited IRAs for each sibling.
When the siblings do not need the money immediately, they can split the assets into an inherited IRA and choose either to:
1. Receive RMDs until you reach age of majority, allowing the assets in the IRA to grow income tax-free; or
As a minor, if you do not need the money immediately, you can keep the assets in the inherited IRA for it to grow income tax-free. Your RMD will be computed based on your attaining the age of majority, after which all the assets in the IRA have to be distributed within the next 10 years.
2. Receive distributions for the next 10 years after the account holder’s death.
You can also opt to directly receive distributions for the next 10 years. Under this method, you need to withdraw all assets by December 31 of the year following the original account holder’s death. Any distribution received from the inherited IRA is subject to income tax.
Creating separate inherited IRAs within one year from decedent’s death
For multiple joint beneficiaries, if you want to split an IRA into separate inherited IRAs for the siblings, you need to make this decision to separate the inherited IRA by December 31 of the year following the original account holder’s death.
For example, if the original account holder died on April 2020, the decision to split the IRA into several inherited IRAs should be made and done by December 31, 2021.
Taking out the RMD for the year of decedent’s death
If the decedent did not take out a RMD on the year of decedent’s death, the designated beneficiary must take out the RMD. Otherwise, there is a 50% penalty of the amount not distributed.
Spouses as eligible designated beneficiaries
Spouses get the most preferred status as eligible designated beneficiaries. They can choose to roll over the IRA into their own IRA, receive RMDs based on their own life expectancy, get distributions and exhaust the inherited IRA within 10 years from the original account holder’s death, or receive a lump sum payment. All these choices have different tax consequences, and it depends on the person’s individual circumstances which option will provide the most beneficial tax consequence.
Above rules only apply in cases where the original account owner dies after December 31, 2019. For accounts inherited in 2019 and earlier, a different set of rules applies.
Inherited IRA rules can be complex. A lawyer with expertise in this particular area can evaluate your case to see which option is the most beneficial given your individual curcumstances. We at the law offices of Albert Goodwin are here for you. We have offices in New York, NY, Brooklyn, NY and Queens, NY. You can call us at 718-509-9774 or send us an email at firstname.lastname@example.org.