What Happens When an Inherited IRA Beneficiary Dies?

When an individual inherits an Individual Retirement Account (IRA), they typically become a “designated beneficiary.” They assume ownership, subject to specific distribution rules. Complexity arises when this initial beneficiary dies before fully distributing the inherited IRA assets, introducing a “successor beneficiary” who inherits an already inherited IRA. Understanding these rules is important for effective management.

Identifying the Next Beneficiary

Determining the successor beneficiary of an inherited IRA depends on established designations and legal defaults. The most direct method is when the initial inherited IRA beneficiary explicitly named a successor on the account’s beneficiary designation form. This ensures funds pass directly to their chosen individual or entity, streamlining the transfer. Custodians may have specific policies regarding whether an inherited IRA beneficiary can name their own successor, so confirm this capability.

If the initial beneficiary did not name a successor, the inherited IRA typically becomes part of their probate estate. Distribution then follows the initial beneficiary’s will or, if no will exists, state intestacy laws. This can lead to the IRA being distributed among various heirs, potentially complicating the process.

The terms “per stirpes” and “per capita” also influence beneficiary identification, especially in multi-generational designations.
A “per stirpes” designation ensures that if a named beneficiary predeceases the IRA owner, that beneficiary’s share passes to their direct descendants.
A “per capita” designation distributes shares equally among the surviving members of a specified group, excluding descendants of any deceased members.
These distinctions are usually set by the original IRA owner or the initial beneficiary when designating beneficiaries, impacting the ultimate recipients.

Understanding Distribution Rules for Successors

Successor beneficiaries generally step into the shoes of the deceased initial beneficiary regarding the remaining distribution schedule of the inherited IRA. They do not receive a new distribution timeline but must continue adhering to the rules that applied to the initial beneficiary. Specific distribution requirements depend on when the original IRA owner died and the initial beneficiary’s status.

For inherited IRAs where the original owner died before January 1, 2020 (pre-SECURE Act), the initial beneficiary may have been distributing funds over their lifetime, often called a “stretch” IRA. If this initial beneficiary dies, the successor generally continues distributions based on the initial beneficiary’s remaining life expectancy, allowing for continued tax-deferred growth.

However, if the original IRA owner died on or after January 1, 2020 (post-SECURE Act), the 10-year rule generally applies to non-spouse designated beneficiaries. The entire inherited IRA balance must be distributed by December 31 of the tenth year following the original owner’s death. When a successor inherits such an IRA, they do not get a new 10-year period; instead, they must complete distributions by the end of the original 10-year window established for the initial beneficiary. For example, if the initial beneficiary died after six years of their 10-year period, the successor has only four years remaining to fully withdraw the funds.

There are exceptions to the 10-year rule for certain “eligible designated beneficiaries” (EDBs) of the original IRA owner. These include:
Surviving spouses
Minor children of the owner
Disabled individuals
Chronically ill individuals
Individuals not more than 10 years younger than the owner

While an initial EDB may have stretched distributions over their lifetime, a successor to an EDB typically does not inherit this status. Instead, a successor to an EDB is generally subject to the 10-year rule, requiring distributions by the 10th anniversary of the initial EDB’s death. Annual required minimum distributions (RMDs) may also apply during this 10-year period if the original IRA owner had already begun taking RMDs.

If the inherited IRA went to the initial beneficiary’s estate rather than a named successor, distribution rules can be more restrictive. The inherited IRA may be subject to the 5-year rule, or the 10-year rule if the original owner died post-SECURE Act, applying to the estate itself. Funds must be fully distributed from the IRA to the estate within that timeframe, and then the estate’s heirs receive the funds according to the will or intestacy laws. This can accelerate tax consequences compared to individual beneficiary distributions.

Process for Account Transfer and Distributions

Transferring an inherited IRA to a successor beneficiary involves communication with the IRA custodian. The process begins with notifying the financial institution of the initial beneficiary’s death, requiring submission of their certified death certificate.

The successor beneficiary must also provide proof of identity and legal documentation establishing their right to the funds, such as a copy of the initial beneficiary’s will, trust documents, or probate court orders. The custodian will require these documents to verify the successor’s claim and ensure proper transfer. The successor beneficiary will then complete specific forms provided by the custodian for a “beneficiary claim” or “transfer to successor beneficiary inherited IRA.”

Once documentation is submitted and approved, the account is retitled to reflect new ownership. A common titling format is “[Original Owner’s Name] Inherited IRA FBO [Successor Beneficiary’s Name],” which acknowledges the original source while identifying the current beneficiary. After the account is established, distributions can begin. Withdrawals can be initiated through the custodian’s online portal or by submitting specific forms. The successor beneficiary is responsible for understanding any required minimum distribution (RMD) obligations for the year of death and subsequent years, ensuring timely withdrawals to avoid penalties.

Tax Implications for Successor Beneficiaries

Distributions from an inherited IRA are generally subject to income tax for the successor beneficiary. Since traditional IRA funds were tax-deferred, meaning contributions and earnings grew without being taxed annually, withdrawals are usually taxed at the successor beneficiary’s ordinary income tax rate. This applies unless the original IRA owner made non-deductible contributions.

A notable advantage for inherited IRAs is that distributions are exempt from the 10% early withdrawal penalty, regardless of the successor beneficiary’s age. This rule applies even if the beneficiary is under 59½, providing flexibility in accessing funds without additional penalties. This exemption is a key distinction from withdrawals made from one’s own IRA before retirement age.

While distributions are subject to income tax, the inherited IRA’s value may also have been included in the initial beneficiary’s taxable estate if subject to federal or state estate tax. This is a separate tax event from the income tax paid by the successor beneficiary upon withdrawal. The successor beneficiary may be eligible for an income tax deduction for any estate tax paid on the inherited IRA, as it is considered “income in respect of a decedent.”

For tax reporting, the IRA custodian will issue Form 1099-R to the successor beneficiary for any distributions taken during the year. This form details the gross distribution, the taxable amount, and any federal income tax withheld. The successor beneficiary must report these distributions on their annual income tax return, typically on Form 1040, using the information provided on Form 1099-R. A distribution code of ‘4’ in Box 7 of Form 1099-R indicates the distribution was due to death and is exempt from the early withdrawal penalty.