26 Feb How is tax paid when an estate is the beneficiary of an IRA?

Q. When an estate is named beneficiary of an IRA, what is the method of distributing it to one individual in the most tax-effective way?
— Beneficiary

A. The named beneficiary of an IRA can have important tax consequences.

When an estate is named the beneficiary of an IRA — or if there is no chosen beneficiary, the estate is usually designated beneficiary by default — the IRA must be paid to the estate and then the account owner’s will or the state law, if there was no will, would determine who will inherit the IRA, said Yale Hauptman, an estate planning attorney with Hauptman and Hauptman in Livingston.

He said when a “non-individual” is the beneficiary of an IRA, it must be distributed within five years if the account owner died before his/her required beginning date for distributions, which was changed to age 72 last year when Congress passed the SECURE Act, he said. If the owner dies after his/her required beginning date then the account must be distributed over his/her remaining single life expectancy, he said.

The income tax on these distributions is payable by the estate, which has a compressed tax bracket, Hauptman said.

“This means that the highest tax rate of 37% is paid on this income when total income of the estate reaches $12,950,” he said. “For individuals, the 37% tax bracket isn’t reached until income is above $518,400 or $622,050 if filing as married.”

For these reasons, leaving your IRA to your estate is not tax-efficient and generally is to be avoided, he said.

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This story was originally published on Feb. 26, 2021.

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