IRA Rules for Five-Year Distributions

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IRA five-year distribution rules apply when an IRA owner dies and the beneficiary of the IRA is not the surviving spouse. The five-year distribution rules are complicated and, if not followed properly, can create a tax liability for the IRA beneficiaries.

Five-Year Rule

  • The IRA five-year rule requires that the entire amount of the IRA distribute to the beneficiaries no later than Dec. 31 of the fifth year after the IRA owner's death. IRA rules require that the owner of the IRA receive mandatory distributions from the IRA at age 70 1/2. The five-year rule only applies if the IRA owner died prior to the mandatory beginning date for distributions, which is any age prior to 70 1/2.

Five-Year Rule Tax Trap

  • The five-year rule states that the beneficiaries must take the balance of the IRA within the required timeframe and does not require that distributions occur until the last day. If a beneficiary does not take any distributions until the end of the five-year period, he will be responsible for income tax on the entire distribution in one year. Any growth in the IRA is also taxable upon distribution, and combined federal and state tax income rates can create a hefty tax liability.

Five-Year Rule Alternative

  • The Internal Revenue Code has an alternative to the five-year rule that provides most beneficiaries with a better way of taking mandatory distributions from the IRA. The life expectancy method of distribution allows an IRA beneficiary to take required distributions annually over the lifetime of the beneficiary. For large IRAs this is a good method because it provides a longer period of time to pay the tax due on the IRA. It is important that a beneficiary make an election to use life expectancy for required distributions, or the Internal Revenue Code requires the default five-year rule.

Seek Advice

  • Many tax traps plague beneficiaries of IRAs. IRA rules are complicated and a beneficiary must decide how to handle IRA elections and distributions in accordance with his personal tax situation and the Internal Revenue Code. Before making any elections on deceased owner IRAs, seek the advice of a tax professional.

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