RMDs to a Trust Beneficiary of an IRA

Many people who inherit an IRA, particularly a substantial one, tend to worry about the five-year distribution rule. This rule requires that the IRA must be depleted in its entirety within that five-year period which, often, will result in a substantial tax event.

 

Under current tax law, the individual who is named beneficiary on the designation form, could select the five-year rule if they choose to. There are other options available that many people might not be aware.  If you inherited the funds from an IRA owner who died before April 1 of the year following the year they reached 70 ½, you have the option to choose the five-year rule.  Remember, that means that the account must be depleted in its entirety within that period of time.  Another option available would be to begin taking the requirement minimum distribution over your life expectancy instead. This would help to alleviate the large tax burden associated with the five-year rule.

 

What happens if the IRA owner died after already beginning requirement minimum distributions and you are named as the beneficiary of the IRA? The five-year rule is no longer applicable and is not even an option.

 

Let’s look at the instances in which the five-year rule does apply. If you inherit an IRA via the settling of an estate rather than being directly named the beneficiary on the designation form, then obviously there is no designated beneficiary. With that being the case, if the IRA owner dies before they begin required minimum distributions, then you will be stuck with the five-year rule. If that is the case but they have begun their RMDs, you can take distributions over the remaining life expectancy of the deceased IRA owner.

 

So, what are those rare times when the five-year rule does apply? This can happen if you inherit IRA funds not by being named directly on the beneficiary designation form but instead through an estate. If that happens there is no designated beneficiary. If the IRA owner dies before the required beginning date, that is the one and only time under the tax rules that you will be stuck with the five-year rule. If the IRA owner dies on or after their required beginning date, you escape the five-year rule and can take distributions over the remaining life expectancy of the deceased IRA owner.

 

Do keep in mind that the majority of IRA documents to do not impose limits on the options available to a beneficiary under current tax long, but some do. There is the possibility that there is language associated with your inherited IRA that could require you use the five-year rule or because of a missed RMD. In these instances, it is your IRA document and not tax rules that are limiting you to the five-year rule.

 

It is important to keep in mind that while most IRA documents do not limit the options to a beneficiary that are otherwise available under tax law, a few do. It is possible that your inherited IRA might include language that would limit you to the five-year rule or would require it as a default for a missed RMD. In these cases, it is your IRA document and not the tax rules that is leaving you stuck with the five-year rule.

 

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