IRA with no listed beneficiaries in an estate - distribution & taxes

[M Paquette]

I’m administering an estate of a deceased brother, who had no spouse, children, or surviving parents. Under California probate law that makes his four surviving siblings, including me, heirs of the estate. There was no will or trust, and no beneficiaries or POD listed for any accounts. There isn’t all that much in the estate besides a small paid-off condo and an IRA, again with no beneficiaries.

The IRA had been run down fairly far by my brother, and the tax impact of distributing it four ways is fairly small. If emptying the account is seen as income to the estate, the tax bite is huge (37% Federal), but if the estate passes through income and losses then the tax bite will be much smaller, as we are all fairly low-income folks. We don’t want to keep the probate estate open for years to do the 5 year minimum withdrawal thing (5, not 10 as the IRA had no named beneficiaries), but would rather wrap it up quickly, for assorted personal reasons. (There’s no guarantee I’ll live that long, for one!)

So, the current plan is to liquidate the IRA, directing the custodian to make no tax withholding, and pass the income through via the K-1 1041 filing we will make as we close the estate. That’s straightforward enough. Yes, I will be engaging a tax person to generate the 1041 and California 541 filings, just to get the paperwork right. (The estate includes several other accounts, the real estate, a bunch of cryptocurrency, and a bunch of expenses.)

The question: Is any special treatment of the IRA funds needed? Can they be put into the estate bank account used to collect other assets, and at distribution passed along, along with the K-1 for each beneficiary? Or do I need the IRA custodian to do something special, such as issuing separate checks to the estate beneficiaries? Or something even more complex?

 

[Dash man]

The IRA will have to be probated and the funds distributed among beneficiaries, who then can put the funds into inherited IRAs within 60 days to avoid immediately paying taxes.

 

[RunningBum]

My understanding is that if no beneficiaries are listed, the IRA is fully distributed and taxed to the estate unless there is a surviving spouse. I've always heard that it is vital to name beneficiaries for your IRAs, including inherited ones, for this reason. But I don't know for sure as my remaining parent no longer has an IRA, and I am making certain to name a beneficiary for mine.

 

[iloveyoga]

My understanding is that if no beneficiaries are listed, the IRA is fully distributed and taxed to the estate unless there is a surviving spouse. I've always heard that it is vital to name beneficiaries for your IRAs, including inherited ones, for this reason. But I don't know for sure as my remaining parent no longer has an IRA, and I am making certain to name a beneficiary for mine.

This is how we did it when I worked in the retirement business. If there was no beneficiary, we paid to the estate.......

 

[M Paquette]

That’s my understanding as well. What I want to do is pass that payment through as K-1 1041 estate income, so its taxed at individual rates among the heirs rather than as estate income at a higher rate.

Because there are no beneficiaries names it looks like the IRA can’t be rolled over to new IRAs, but must be distributed within 5 years, and of course before the estate is closed.

 

[DayDreaming]

...
The question: Is any special treatment of the IRA funds needed? Can they be put into the estate bank account used to collect other assets, and at distribution passed along, along with the K-1 for each beneficiary? Or do I need the IRA custodian to do something special, such as issuing separate checks to the estate beneficiaries? Or something even more complex?

I had a similar situation and just filed the 1041 this week. My mother had an IRA that listed myself and my brother as beneficiaries, so we each got half of that with no problem. She had another small IRA with my father (deceased) as beneficiary, and no secondaries listed. So this one had to be paid to the estate, and was deposited in the bank account along with all other estates proceeds. That IRA issued a 1099-R to the estate, showing the gross distribution as fully taxable.

To answer your question, no special treatment of the funds was needed, it was simply an IRA withdrawal. The 1099-R shows the 1) Gross Distribution and 2a) Taxable amount as the same, the box "total distribution" is checked, the box 7) distribution code is 4 (death).

 

[gauss]

IRA distributions to an estate or other beneficiary do need special handling IMHO, but not by the IRA custodian. There is a pitfall on the Federal 1041 K1 form that you should be aware of -- even if you hire some to prepare the 1041 for you.

IRA distributions would typically be reported on line 5 Other portfolio and nonbusiness income on the K1. The problem is that this is a bit of a catch-all, miscellaneous category. Most consumer 1040 tax software will assume that this income is subject to the NIIT of 3.8% if the return has income of sufficient levels where NIIT might apply. This is not the case for IRA distributions - they are exempt from NIIT regardless of income level.

The trick to avoid this is to show a negative entry on box 14 Code H of the K1. Box 14 is Other Information and Code H is specifically setup as an NIIT adjustment.

I learned this the hard way, so I speak from personal experience on this one.

-gauss

 

[M Paquette]

Good to know!

As an update, we have determined that there IS a beneficiary listed for the IRA. In my original conversation with the IRA custodian, I suspect that they just checked beneficiaries for the associated checking account. Once they actually had to have their legal department start processing all the claiming paperwork, someone there noticed a beneficiary form had been filed a few decades back.

That makes the estate much simpler. Since the assessments done by both the county assessor and the probate referee were much higher than what the largest remaining asset, the “condo”, actually sold for (a 1960 1 bedroom apartment with original cabinetry and flooring, “condoized” in 1978 and bought by my deceased brother), the estate is going to show a loss on the asset liquidations, and won’t pass along taxable income. There was just a pair of checking accounts, a small brokerage account, and a small Roth IRA.

I’ll have this headache wrapped up as soon as we can schedule a session with probate court.

 

[gauss]

Do you know if the named beneficiary from decades earlier is still alive?

If not, it is possible that the funds would come back to the estate.

The sticky situation might be if beneficiary is alive but doesn't come forward to claim the IRA.

I wonder if the custodian would be able to confirm the status if the beneficiary has come forward or not.

Worse case, you could always close the estate and follow the unclaimed property web site in the state of your brothers residence (CA?). If the funds show up there in a few years the estate could take steps to claim -- but might need to reopen the Estate.

I have personal experience in this sort of thing also -- administered 3 separate estates over a 10 year period.

-gauss

 

[Exchme]

If it is taxed to the estate, then each heir can get a portion of that back, see Income in Respect of a Decedent, for example a Kitces article:

The IRD Deduction Inherited IRA Beneficiaries Often Miss

The IRC Section 691(c) income in respect of a decedent (IRD) deduction allows beneficiaries to claim a significant income tax deduction for estate taxes paid!

www.kitces.com

 

[M Paquette]

Do you know if the named beneficiary from decades earlier is still alive?

If not, it is possible that the funds would come back to the estate.

The sticky situation might be if beneficiary is alive but doesn't come forward to claim the IRA.

I wonder if the custodian would be able to confirm the status if the beneficiary has come forward or not.

Worse case, you could always close the estate and follow the unclaimed property web site in the state of your brothers residence (CA?). If the funds show up there in a few years the estate could take steps to claim -- but might need to reopen the Estate.

I have personal experience in this sort of thing also -- administered 3 separate estates over a 10 year period.

-gauss

Oh, he’s alive, and will definitely be happy to receive the IRA. I intend to assist him in claiming the funds. He very much need this. The other estate heirs don’t.