Disclaiming All or Part of an Inherited IRA or Retirement Plan. What is it?
If you are a beneficiary of a traditional IRA or employer-sponsored retirement plan account, and the account owner dies, you generally have several options. In most cases, one of your options is to disclaim the inherited funds. When you disclaim all or part of a traditional IRA or retirement plan account, you voluntarily refuse to accept some or all of the inherited funds.
Why would someone disclaim?
As you might guess, disclaiming is not common. Most beneficiaries opt to receive the inherited IRA or employer-sponsored plan funds in one form or another. However, disclaiming a benefit may actually make sense in certain circumstances. For example, you may decide to disclaim so that the funds pass directly to a contingent beneficiary with greater financial need. Or, you may want to disclaim in order to minimize your taxable income or for estate planning purposes. IRA and retirement plan distributions are generally treated as taxable income for federal (and possibly state) income tax purposes and can be subject to estate tax, too. Or you may want to disclaim to allow the IRA or retirement plan account to pass to a younger contingent beneficiary who can stretch out distributions over a longer period of time.
Requirements to make a disclaimer
To disclaim funds from a deceased IRA owner's or plan participant's account, you must have a claim on those funds in the first place. In other words, you must be a beneficiary of the IRA or plan account. When you disclaim the account, it passes to the contingent beneficiary. You may disclaim the entire IRA or retirement plan or just the portion that you do not want, but either way it must be a "qualified" disclaimer to avoid being classified as a gift from you to the contingent beneficiary for federal gift tax purposes.
A qualified disclaimer is (1) irrevocable and unconditional, (2) in writing, (3) given to the plan custodian or administrator within nine months of the creation of the interest (or, if later, nine months after you turn 21) and before you have access to, or use or enjoyment of, the funds, and (4) causes the IRA or plan to pass directly to the secondary (contingent) beneficiary without you directing where it goes.
Tip: In most cases, the nine month period starts on the date of the account owner's death for purposes of disclaiming IRA and retirement plan benefits.
To disclaim inherited IRA or plan funds, you generally must not have selected another payout option for the funds. If you have already elected to take distributions from the account, you may not later disclaim in most cases. If you are considering disclaiming the inherited funds, you should seek professional advice before taking any action with respect to the inherited account. Even exercising investment control over the account could jeopardize a future disclaimer.
Tip: There is one important exception. If the account owner has not taken a required minimum distribution(RMD) for the year of death the IRA or retirement plan beneficiary must take that distribution by December 31 in order to avoid a 50% tax penalty. The IRS has ruled that taking this RMD will not prevent the beneficiary from making a timely disclaimer of all or part of the remaining IRA or retirement plan benefit (although the beneficiary can not disclaim any earnings attributable to the RMD). This helpful ruling (Rev, Rul. 2005-36) lets a beneficiary take the year-of-death RMD while providing further time to consider whether or not to disclaim the balance of the IRA or retirement plan benefit.
Caution: You can disclaim funds from an inherited Roth IRA as well. However, since qualified distributions from a Roth IRA are tax free, the considerations are slightly different.
Qualified disclaimers, RMDs, and designated beneficiaries
In April 2002, the IRS issued final regulations on required minimum distributions. The final regulations were effective starting on January 1, 2003. The regulations establish September 30 of the year following the year of the account owner's death as the date by which the determination of designated beneficiaries must be finalized. If you make a qualified disclaimer (as defined above) by this September 30 date, you will generally not be treated as a designated beneficiary of the IRA or plan for purposes of calculating post-death distributions (this is separate from the issue of whether the disclaimer was effective for estate and/or gift tax purposes).
Caution: The September 30 date does not operate to extend the deadline for making a qualified disclaimer—that is, a qualified disclaimer must generally be made within 9 months after the account owner's death.
Advantages of disclaiming
You will not pay income tax on the disclaimed funds
As mentioned, post-death distributions from IRAs and retirement plans are generally subject to federal income tax. (If the IRA or plan consists of any nondeductible or after-tax contributions, those amounts are not taxable when distributed.) State income tax may also apply. However, when you disclaim inherited IRA or plan funds, you pay no income tax on those funds because you never actually receive them. Instead, the party that receives the funds as a result of your disclaimer (usually one or more contingent beneficiaries) will pay income tax on distributions of those funds.
Disclaiming can thus be a beneficial strategy if you do not need the inherited funds, and one of your goals is to minimize your taxable income. This may be especially true if the inherited funds would push you into a higher income tax bracket, causing the funds to be taxed at a higher rate.
Your estate will not pay estate tax on the disclaimed funds
With a qualified disclaimer, the disclaimed funds are not part of your estate for gift or estate tax purposes. Depending on the estate tax bracket of your estate, this can result in a significant tax savings.
You can decide how much to disclaim
Generally, if an IRA owner or retirement plan participant dies, and you are a designated beneficiary of the account, you can choose to disclaim all or a portion of the funds that you inherit. This gives you some flexibility to tailor your decision regarding those funds to your own needs and situation. You may opt to disclaim your entire share of the inherited funds for tax reasons. Or, you can disclaim a portion of the funds and receive the other portion as distributions.
A disclaimer may benefit others with greater need
Typically, if you are a primary beneficiary of the IRA or plan, the portion of the funds that you disclaim will pass to one or more contingent beneficiaries (assuming there are contingent beneficiaries named in the IRA or plan documents). This may be a very desirable outcome if the contingent beneficiaries are family members or other loved ones who have greater financial need than you. For example, this might be the case if you are the child and primary beneficiary of the account owner, and your children are the contingent beneficiaries. Allowing the funds to pass to contingent beneficiaries can also be advantageous if those individuals are in a lower income tax bracket than you, and/or if they can take post-death distributions over more years than you would be able to.
Disadvantages of disclaiming
You will not receive the inherited funds
When you disclaim inherited IRA or retirement plan funds, the portion that you disclaim typically passes to someone else and is unavailable to you. If you instead accepted the inherited funds, you would have additional money to meet expenses and/or invest elsewhere.
If you have already received a distribution, you may not disclaim later
When you inherit an IRA or retirement plan, you must make a timely decision about how you want the funds distributed and submit the appropriate forms to the IRA custodian or plan administrator. If you have had access to, or use or enjoyment of, the funds (typically, this means that you have received one or more distributions, or you have exercised investment control over the account), you may not change your mind later and disclaim the funds. Similarly, if you elect to disclaim the inherited funds, you typically may not decide later that you want to receive distributions instead. Your first decision is generally final, so you should carefully weigh your options and seek professional advice.
Example(s): Rita inherits a traditional IRA from her husband, Nick. She needs money immediately to pay her tuition at the local beauty school. She takes a large distribution from the inherited IRA and puts it into her checking account. Before she writes the check, she wins a scholarship for tuition and fees. Now Rita would like to disclaim the IRA so that it will go directly to the contingent beneficiary, her son Ricky. However, it is too late. Having already taken a distribution (and having been given access to the funds), Rita may not now disclaim the IRA.
Tip: See "Requirements to make a disclaimer," above, for a special rule regarding required minimum distributions.
You may not choose who will receive the assets in your place
If you elect to disclaim an inherited IRA or retirement plan, the funds typically pass to the contingent beneficiaries. This outcome may be desirable if you want the contingent beneficiaries to benefit, but that may not be the case. Further, if there are no contingent beneficiaries (or if they too disclaim), the disclaimed funds will typically pass to the account owner's estate. This is usually not desirable because post-death distribution options will be limited and the funds will have to go through probate before being distributed to the beneficiaries and/or heirs of the estate. Being named as a beneficiary of an IRA or plan does not give you the power to decide who should receive the inherited funds if you choose to disclaim--that is determined by who is named as the alternate takers on the beneficiary designation form or, if there is a gap in the designations, who the takers are under state law.
How to make a disclaimer
You will need to contact the IRA custodian or plan administrator to request the necessary form for disclaiming either all or part of the inherited funds. Unless you expressly disclaim, you are presumed to have accepted the funds. Get legal and tax advice before signing a disclaimer. Return the form with any necessary documentation (such as identification and a death certificate), indicating that you want to disclaim all or a portion of the balance. Disclaimer forms vary from state to state, so you should consult the IRA custodian or plan administrator regarding whether you need an attorney to prepare the necessary form. In addition, be sure to make a qualified disclaimer in a timely manner.
If you disclaim only a portion of the IRA or plan funds, you will need a withdrawal form to indicate how you want to receive the remaining portion. Disclaimers have significant tax and financial consequences--get legal advice before deciding to disclaim. Also, get advice very soon after a death, because actions you take after someone's death may prohibit you from making a qualifying disclaimer under the applicable federal and state tax laws.
This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.
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