IRA BDA – No Beneficiary Designation
IRA holder passes away at age 62 in April. No beneficiary designation on IRA and no will. A close attorney friend of the decedent petitions the court and is appointed to act as executor. He determined that the decedent’s two sisters, the only surviving blood relatives, are sole beneficiaries of the estate.
To pass the IRA’s assets down to the sisters, I believe the IRA first has to be retitled into an IRA-BDA, owned by the estate. Since the estate is not a person, there is no life expectancy option to distribute the assets. I think the only options are to distribute a lump sum (to the estate) or distribute the entire IRA (to the estate) within the five years subsequent to the year after death.
If my above assumptions are correct, does the estate pay income tax on the distributions at the estate level, or can the income be passed down to the two sisters for them to claim on their individual income tax returns?
Alternatively, can the IRA-BDA be split into two IRA-BDA’s with the sisters’ names so that they can control the investments, transfer their IRA’s to another broker if so desired, and take distributions directly (subject to the five year requirement)?
Bottom line – what would be the correct steps to take in distributing the money to the two sisters and paying the applicable income tax?
Thank you.
Permalink Submitted by Alan Spross on Wed, 2009-07-29 22:26
You are correct about the BDA re registration and the 5 year rule applying here, assuming that the default beneficiary on the IRA agreement is the estate.
The IRA distributions to the estate are generally passed through to each estate beneficiary on a K1, and taxed at their individual marginal rates. Estate tax rates are very compressed, meaning the rates are typically much higher than what the individual would pay when distributions are passed through on the K1.When the estate is terminated the IRA can then be assigned to the respective beneficiaries. Alternatively, if the estate could be closed without any IRA distributions passed through, and then each beneficiary can be assigned their share of the IRA and take out as little or as much of the account as they need each year. If the IRA is sizeable, spreading the distributions over 5 years will be more tax efficient than a lump sum.
In fact, the distribution deadline is 12/31/2014, meaning that distributions could actually be spread out over 6 years (2009-2014). Once the IRA is assigned to the estate beneficiaries, they can split and transfer the account to new IRA custodians if they desire.
Note that the IRA custodian will probably prefer to just make an LSD to the estate, but this is not to their advantage, and should be resisted unless it somehow fits better with their plans and they both want the cash ASAP.
Permalink Submitted by mk foss on Thu, 2009-07-30 01:23
I agree with Alan (of course). Another consideration is the probate process. Although an IRA should not be subject to probate it becomes one when the estate is the beneficiary (either named or by default). That means that the probate judge will also have a say in the timing of distributions. Ordinarily distributions to the beneficiary occur when the estate closes so Alan’s suggestion of distributing the IRA to the two beneficiaries will still work but if there are insufficient assets to pay debts and expenses, the IRA may have to be tapped early with income taxes to pay.
Distributions of assets to the beneficiaries will cause income earned in the same tax period to be also “distributed” – that’s a way of reducing the overall tax rate on the IRA distributions but can only occur within the distribution framework specified by the probate judge. You should consult an attorney that is a specialist in estate administration.
Permalink Submitted by [email protected] on Thu, 2009-07-30 14:59
Thank you for the replies. My concern was that the estate would have to pay the tax at the compressed level. Being able to pass the income down to the beneficiaries on the K-1 and paying tax at their individual rates will be more palatable. I also was not aware that the estate could be terminated or closed before any IRA distributions are made, and at that point each beneficiary’s half of the IRA be assigned to them individually. That would seem like a much better option.
There are other significant nonqualified assets in the estate to pay all the expenses and taxes, so the IRA would not have to be tapped prior to estate termination.
Permalink Submitted by Bruce Steiner on Thu, 2009-07-30 16:26
While having an IRA payable to the IRA owner’s estate is generally not a good idea, it’s not quite as bad as others have suggested.
As Alan pointed out, since you get 5 years from the end of the year in which the IRA owner dies, you in effect get 6 years. And if the estate chooses a fiscal year, you can get 7 taxable years.
If the estate is too small to pay Federal estate tax (a more likely scenario now that the exempt amount is $3.5 million), the administrator can deduct the estate’s administration expenses (mainly legal fees and the administrator’s commissions) on the estate’s income tax returns. If that is the case here, the administrator can thus use these expenses to offset some of the income from the IRA.
While many executors and administrators wait until the end of the estate administration to make distributions, the administrator can make interim distributions to the sisters, which will carry out income. The administrator can thus spread the income out among 3 taxpayers (the estate and the 2 sisters), and over 21 taxable years (7 taxable years for each sister and 7 taxable years for the estate. This may help to keep the income tax brackets down.
It may also be possible for either or both sisters to disclaim some or all of their interests, if the disclaimed interest would then go to the disclaiming sister’s children, and if that is acceptable to the sister.
I can’t speak for all 50 states, but in most states the probate court has very little to do with the estate administration.
Given the nature of these questions, the administrator may wish to consult with tax/estates counsel, who can give him more specific advice on this and on any other tax aspects of this estate administration.
Bruce Steiner, attorney
NYC
also admitted in NJ and FL