IRA should have designated beneficiary for best tax result

This column first appeared in the San Antonio Express News and other Texas Hearst Newspapers on August 17, 2018.


An IRA (individual retirement account) is a tax-deferred savings program used by millions of Americans to help fund their retirements. IRAs are great tax and retirement tools, and they need to be integrated into each person’s estate planning. Universally, when an IRA is established and funded, the owner also designates specific individuals to receive the funds in case of death. At age 59 ½ the owner is allowed to make withdrawals from the IRA, subject to income tax, but penalty free. At age 70 ½ the owner must make annual required minimum distributions (RMDs) from the IRA, subject to income tax.

If there is still money in the IRA when the owner dies, the custodian (bank or brokerage holding the funds) waits for a claim from the designated beneficiaries, and presentation of the death certificate. The designation of beneficiaries is binding and overrides the owner’s Will. The owner can name as beneficiary a) individuals, b) charities, c) the owner’s estate, or d) a trust with special terms. Each type of beneficiary may have different withdrawal rights and different income tax consequences. Some examples:

  1. A surviving spouse is special and may roll-over the decedent’s IRA to become the spouse’s IRA. The surviving spouse can then choose to make withdrawals after age 59 ½ or wait until RMDs are necessary at age 70 ½.

  2. Another individual, like one or more of the owner’s children, they can treat the IRA as an “inherited IRA”, making withdrawals over the beneficiary’s lifetime. They do not get to defer withdrawals from the inherited IRA until they reach 70 ½; rather, they must take an annual withdrawal each year based on their statistical life expectancy as predicted on a Table published by the IRS.

  3. A trust with proper terms can be treated like an individual, so long as the trust’s beneficiaries are identifiable, the trust is irrevocable, the trust is legal under state law, and the custodian of the IRA timely receives a copy of the trust.

  4. An estate cannot be treated as a designated beneficiary, nor can a trust which lacks proper terms. If the owner died before starting to take distributions from the IRA, then the estate or trust must pay taxes on all of the IRA funds within five years of the owner’s death. If the owner died after starting to take distributions from the IRA, then the estate or trust must take withdrawals at least as rapidly as the owner would have taken them if still living.

  5. A charity can receive the IRA, and since it is tax-exempt, it can withdraw all of the funds immediately without paying any income taxes.

Your answer falls into category D. Because the IRA is payable to the estate, there  must be a probate of her Will and appointment of any Executor. The Executor, on behalf of the estate, must withdraw the IRA funds and must pay the taxes from the IRA funds. They can be paid in a lump sum as though withdrawn in one year or can be paid as though they were drawn out over five years (which may lower the tax bill). The devisees named in the Will, then, get money from the Executor of the estate post-tax. They do not have to again pay income taxes.

Paul Premack is a Certified Elder Law Attorney with offices in San Antonio and Seattle, handling Wills and Trusts, Probate, and Business Entity issues. View past legal columns or submit free questions on legal issues via www.TexasEstateandProbate.com or www.Premack.com.

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Paul Premack, 2019-2020 President of the Texas Chapter of the National Academy of Elder Law Attorneys (NAELA) is *Certified as an Elder Law Attorney ( CELA ) by the National Elder Law Foundation as accredited by the Texas Board of Legal Specialization and the ABA. He is licensed to practice law in Texas and in Washington State, and handles San Antonio Probate and Bexar County Probate, Wills, Living Trusts, Estate Planning, and writes the legal column for the San Antonio Express News.

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