Strategies for IRA Distributions to Family and Charity – Part II

BEQUEST OF IRA TO FAMILY MEMBERS

Spousal Rollover
When an IRA owner passes away, the IRA is transferred according to the IRA beneficiary designation form. If the IRA owner passes away with the surviving spouse as the sole beneficiary, the surviving spouse can choose to roll over the inherited IRA into a new or existing IRA in the surviving spouse’s name. If the surviving spouse has not yet reached age 70½, then he or she can delay distributions until age 70½ instead of being forced to continue to take the deceased IRA owner’s RMDs. Note that, with this option, the traditional IRA rules apply. Therefore, the surviving spouse must begin taking distributions at age 70½ and could face penalties if a distribution is taken prior to the age of 59½. In addition, the surviving spouse’s distributions will be fully taxable at ordinary income tax rates.

Spousal Inherited IRA
Another option for a surviving spouse is to receive distributions under the original IRA owner’s plan as an inherited IRA. With this option, the surviving spouse will begin taking distributions right away. Thus, this option may be attractive for a surviving spouse who is under age 59½ and needs to access the IRA funds immediately, since the surviving spouse will not be subject to an early withdrawal penalty under this method. If the deceased IRA owner had not reached the age of 70½ when he or she passed away, then the surviving spouse can choose to delay taking distributions until the date after which the deceased IRA owner would have reached age 70½.

IRA to Children
If an IRA owner is unmarried or survives his or her spouse, often the first instinct is to designate children as beneficiaries. Unfortunately, this carries negative consequences because the children will be required to pay tax on the value received. If the IRA owner died prior to age 70½, then the children can either choose to take out the entire amount of the IRA within a five-year period or to “stretch” out the distributions over the children’s life expectancy as an inherited IRA.

If the IRA owner was 70½ or older at the time of death, the default is for the distributions to continue to the children under the deceased IRA owner’s original RMD schedule. Alternatively, the children can elect the stretch method described above.

Regardless of the option selected, the children will have to pay ordinary income tax on the entire distribution amount received. This greatly diminishes the inheritance amount that is ultimately passed on to children.

Example 2:

Richard, age 80, designates his daughter Linda as beneficiary of his IRA. When Richard passes away, Linda is 59 years old and decides to stretch out the distributions from the IRA using the IRS’s “Single Life Expectancy Table” to calculate her own RMD. The balance of the IRA in the year that Richard passes away is $500,000. Linda will begin receiving distributions the following year. The distributions will be calculated based on her life expectancy of 25.2 years under the Single Life Table. Linda’s first distribution will be equal to $500,000 divided by 25.2, or $19,841. With her federal income tax rate of 32%, Linda will owe $6,349 of tax on the distribution, thereby reducing the distribution to $13,492 after tax. Each year, Linda’s distributions will increase. After 26 years, the account will be fully distributed.

If you would like to support a favorite Catholic church, school, or ministry through an IRA contact Scott Hartman (614-443-8893 or shartman@catholic-foundation.org) for additional details.

Disclaimer: We’re not accountants, this does not constitute tax advice. Please consult a tax professional.