IRS Beneficiary Trust Rules for IRAs

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IRS regulations for beneficiaries of an IRA vary among the different type of IRA accounts. Generally, the year following the death of the IRA holder, the beneficiary must act to disburse any proceeds in the account. It is advisable for beneficiaries to consult professionals who understand the inner workings and details of any particular case in order to avoid the severe penalties that come with misapplication of the rules.

Who is an IRA Beneficiary?

  • The beneficiary of an IRA need not be an individual. It may be a trust, it may be funds left to an estate, it may be a group of individuals. Generally the same rules apply in every case. Beneficiaries are defined by Internal Revenue Service rules. It is IRS Publication 590 that speaks particularly to the naming of beneficiaries (see resources, below). It is important to note that naming a beneficiary must be done outside the IRA. This is because the spouse can immediately inherit the IRA and leave the beneficiary the remainder after his or herr death. IRA funds gifted to a charity must be recognized in the year they are received by the trust.

The Trust as Beneficiary

  • An increasingly common practice is to use a trust to convey assets. Trusts can protect holders from failed marriages, creditors and the like by holding the asset outside the assets of the individual for whom they are intended. Trust beneficiaries are still subject to the same rules for drawing down the proceeds of the IRA as individuals.

The IRS Formula for Redeeming Trust Proceeds

  • Publication 590 details the rules for beneficiary recognition of income. The year following the inheritance begins the first year of withdrawal. Withdrawal must take place by the 31st of December. Beneficiaries must not co-mingle funds from the inherited IRA with their own. Table 1 of Publication 590 details the formula for withdrawal. The formula is based on the age of the beneficiary and his or her expected lifespan.

IRS Rules Protect Spouses from Beneficiary Rules

  • Upon death, the IRA immediately accrues to the benefit of the spouse. It is the spouse's choice when to make the withdrawal or even just combine the inherited IRA into his or her own IRA. This is the only exception to the rules of Table 1 from Publication 590. No other traditional IRA allows co-mingling of funds under any situation.

Disallowance of a Beneficiary

  • It is the right of any beneficiary to refuse an IRA. IRS regulations acknowledge the right of any party to refuse a gift. This occurs when the beneficiary chooses (perhaps for tax reasons, perhaps for charity) to disavow a gift, fill out the proper IRS forms, and let the gift fall to the estate and be divided by the terms of the will.

References

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