The distribution rules for inherited individual retirement accounts (IRAs) generally make it advantageous to separate accounts for each beneficiary, which can be done during your life or by December 31 of the year following your death. If you plan to leave an IRA balance to several beneficiaries, consider splitting each beneficiary's share into a separate account during your life. Why is it important to have separate accounts?
Your spouse will have more alternatives available if he/she is the sole beneficiary. A surviving spouse can roll over the IRA to an IRA in his/her name or treat your IRA as his/her IRA. With the roll-over IRA, the surviving spouse can name his/her own beneficiaries, thus extending the IRA's life, and can defer payouts until age 70 1/2. However, to roll over the IRA, the surviving spouse must be the sole beneficiary.
When there is more than one non-spousal beneficiary for an inherited IRA, distributions must be taken over the oldest beneficiary's life expectancy. By splitting the IRA into separate accounts, each beneficiary can take distributions based on his/her life expectancy.
Separating accounts is especially important when one of the beneficiaries is not an individual or qualifying trust, such as a charitable organization. If you die before required distributions begin at age 70 1/2, then the entire balance must be paid out in five years. If you die after required distributions begin, the balance must be paid out over your remaining life expectancy. When the account is split, each individual beneficiary can take distributions over his/her life expectancy.
An important estate planning strategy for inherited IRAs is the ability to disclaim all or a portion of the IRA. If a beneficiary disclaims an IRA within nine months of the decedent's death, the disclaimed IRA is not considered a gift and then goes to the contingent beneficiary. By splitting the IRA into separate accounts, you can better control what would happen if each beneficiary disclaims his/her share. For instance, your beneficiaries might be your two children, with your grandchildren named as contingent beneficiaries. With separate accounts, each child could decide whether to disclaim the IRA, knowing the proceeds would then go only to his/her children.
From an administrative standpoint, it is often easier to have only one IRA rather than several. But with separate accounts, you can ensure that your IRA will work to the best advantage of your beneficiaries.