You might want to decline inheriting an IRA if you are the named beneficiary.
The other day, I talked with a couple with two million and one million in their respective IRA accounts. They have two children.
The rules governing inherited Individual Retirement Accounts (IRAs) have changed over the years with the SECURE Act and amendments. They have become even more complex since the passage of the original SECURE Act. The inheritor of an IRA may be required to empty the account and pay taxes on the resulting income within ten years. In some situations, beneficiaries might choose to execute a Qualified Disclaimer and avoid inheriting the IRA, according to a recent article, “How to Opt Out of Inheriting an IRA” from Think Advisor.
When the first spouse dies, the primary beneficiary for each IRA is now the other spouse. Who the backup beneficiary is becomes an essential planning tool later. A disclaimer is a useful but blunt instrument. You can decline to inherit an IRA but have no right to redirect it. The disclaimed item goes as if the first beneficiary were dead. I think of it as a bullfighter. You can move out of the way, but the bull will go where it will.
If one spouse takes the entire IRA when the first spouse dies, the survivor has three million dollars in their IRA. At death, the children may need to take 1.5 million of inherited taxable money out of their IRA each in ten years, boosting their taxable income by $150,000 annually.
Paying taxes on the distributions could put a beneficiary into a higher tax bracket. In some situations, beneficiaries may want to execute a Qualified Disclaimer and avoid inheriting both the account and the tax consequences associated with the inheritance. A disclaimer is a legal statement to decline all or part of something inherited.
Individuals who use a Qualified Disclaimer are treated as if they never received the property. Of course, you don’t enjoy the benefits of the inheritance but don’t receive the tax bill.
At the first death, the surviving spouse could decline inheriting an IRA, or a portion of it, allowing the children to stretch the withdrawal by up to ten more years, decreasing their income tax hits.
An experienced estate planning attorney must ensure that the Disclaimer satisfies all requirements and is treated as a Qualified Disclaimer. It must be in writing, and it must be irrevocable. It also needs to align with any state law requirements. It is also critical that the contingent beneficiaries are correctly in place and verified before the Disclaimer is signed.
The person who wishes to disclaim the IRA must provide the IRA custodian or the plan administrator with written notice within nine months after the latter of two events: the original account owner’s death or the date the disclaiming party turns 21 years old. The disclaiming person must also execute the Disclaimer before receiving the inherited IRA or any of the benefits associated with the property.
Once you decline to inherit an IRA, the inherited IRA must pass to the remaining beneficiaries without the disclaiming party’s involvement. The disclaiming party cannot directly decide who will receive their interests, such as directing the inherited IRA to go to their child. If the disclaiming party’s child is already named as a beneficiary, their interest will be received as intended by that child.
The person inheriting the account must execute the Disclaimer before receiving any benefits from the account. Even electing to take distributions will prevent the Disclaimer from being effective, even if the person has not received any funds.
In some cases, you may be able to disclaim a portion of the inherited IRA. However, these are specific cases requiring the experience of an estate planning attorney.
Reference: Think Advisor (Feb. 8, 2024) “How to Opt Out of Inheriting an IRA”
