What Happens to an IRA After the Beneficiary Dies?

One of the unanswered questions in many estate plans is what happens to an IRA after an initial beneficiary passes away.

First, let’s clear up some confusion about some IRA terms.

A beneficiary is a person who benefits from, or inherits, an IRA after the original owner passes away. A primary beneficiary is named as the first person to inherit the IRA after the owner passes away.

There also can be a contingent beneficiary. This is a person who becomes the beneficiary if the primary beneficiary passes away before the owner passes away. There also can be a successor beneficiary. This is the person who follows the primary beneficiary when the primary beneficiary outlived the original owner. In other words, a successor beneficiary is a beneficiary’s beneficiary.

More than one person can be named to any of these roles, so there can be co-beneficiaries. To keep the discussion simple, I’ll assume only one person at a time is named as a beneficiary.In this discussion, we’re interested in the successor beneficiary and the rules that apply to one.

Suppose Max Profits established a traditional IRA and is the original owner. Max named his son, Hi, as the primary beneficiary. After Max passes away, Hi inherits the IRA and is subject to the rules of the SECURE Act for taking distributions. We’ll assume Hi was an adult when he inherited, so the 10-year rule applies. Hi has to distribute the IRA within 10 years.

But what happens to the IRA if Hi doesn’t live 10 years?

It is likely that a successor beneficiary will take over the IRA. Who will that be?

It is possible that the IRA custodian’s plan agreement names the successor beneficiary. Some retirement plans don’t allow a successor beneficiary to be named. Instead, the plan documents determine who the successor beneficiary is, usually naming the estate of the primary or contingent beneficiary as the successor beneficiary.

This is not the usual case, but it does happen.

The original IRA owner, in this case Max Profits, might have named a successor beneficiary in the original beneficiary designation document or by naming a trust as the primary beneficiary of the IRA. That also is unusual.

The most likely situation is that after Hi inherited the IRA, he was given the opportunity to name a successor beneficiary. If he exercised that right, he probably named primary and contingent successor beneficiaries.

If no beneficiary was named by any of these methods, then the estate of the primary beneficiary would be the successor beneficiary.

Since the estate is not an individual, the IRA would have to be distributed within five years after the primary beneficiary’s passing.Once the successor beneficiary is determined, the next question is how the successor beneficiary is affected by the SECURE Act’s requirement that most inherited IRAs be distributed within 10 years.

There are three possible scenarios for successor beneficiaries.The first scenario is that the primary beneficiary inherited the IRA after the SECURE Act and was an eligible designated beneficiary (EDB). An EDB is a beneficiary who wasn’t subject to the 10-year rule, such as a surviving spouse who treated the IRA as an inherited IRA, a minor child, or a disabled or chronical-ly ill individual.

The second scenario is the primary beneficiary inherited the IRA before the SECURE Act took effect, making the primary beneficiary eligible to use a Stretch IRA.In either of these two scenarios, the result is the same.

The successor beneficiary must distribute the entire IRA within 10 years after inheriting it. The SECURE Act specifically said that none of the exceptions to the 10-year rule apply to a successor beneficiary. In other words, a successor beneficiary can’t be an EDB, even if the successor is a minor child or a disabled or chronically ill individual.

There’s a narrow exception when a surviving spouse treated the IRA as an inherited IRA but died before the original owner would have reached age 72, the year in which required minimum distributions must begin. Anyone who is a successor beneficiary in that situation should discuss their options with a tax advisor.

The third scenario is the primary beneficiary inherited the IRA after the SECURE Act and was subject to the 10-year rule.The result for the successor beneficiary in this case is rather harsh. The successor beneficiary does not get a new 10-year period. Instead, the 10-year period of the primary beneficiary continues. The successor beneficiary has to distribute the IRA by the end of the primary beneficiary’s 10-year period.

Suppose Max Profits named his son Hi as primary beneficiary of his IRA. Hi inherited the IRA at age 48 and named his daughter, Maxine, as his primary beneficiary. Hi lives only four more years. Maxine is the successor beneficiary and must distribute it within six years. Under these rules, successor beneficiaries have few options with the inherited IRAs.

Most must be distributed within 10 years or less.These rules apply equally to Roth IRAs and traditional IRAs. When a Roth IRA is inherited by a successor beneficiary, it probably is best to leave the money in the IRA as long as the law allows, permitting the tax-free compounding of the Roth IRA to be maximized.

When a traditional IRA is inherited by a successor beneficiary, it probably is best to take distributions in installments over the required distribution period. This allows the successor beneficiary to manage his or her tax burden. An amount can be distributed each year that is just enough to keep from pushing the beneficiary into the next highest tax bracket.

Higher distributions might be taken in years in which the beneficiary has large deductions or lower-than-usual income. Taking the distributions in installments makes it less likely that a large distribution will push the beneficiary into a higher tax bracket.