Inherited an IRA? Here’s When an RMD Must Be Taken Before a Transfer

One of the most confusing questions about inheriting an IRA is whether the beneficiary must take a distribution before moving the account to a beneficiary IRA. One financial institution says yes, and another says no. They can both be right. The answer depends on the financial institution’s operational procedures.

Tax Reporting Is the Fundamental Rule

While an IRA owner is alive, distributions from the IRA are reported on Form 1099-R under the owner’s name and taxpayer identification number. After the owner’s death, distributions are made to a beneficiary and must be reported under the beneficiary’s name and TIN. The beneficiary could be an individual, trust, estate, or other person or entity entitled to inherit the IRA.

Important reminder: The IRS requires beneficiary IRAs to be registered in the name of the decedent and the beneficiary, identifying who is the decedent and who is the beneficiary.

This reporting rule also applies when the owner was required to take a required minimum distribution for the year of death. If the IRA owner takes the RMD while alive, the distribution is reported to the owner and included on the owner’s income tax return. But if the owner dies before taking the full RMD, the remaining amount must be distributed to a beneficiary, reported to that beneficiary and, to the extent taxable, included in the beneficiary’s taxable income.

Bottom line: The IRA custodian must be able to report the postdeath distribution under the name and TIN of the beneficiary who receives it. How the custodian meets that reporting requirement is driven by its operational procedures.

Must You Take the RMD Before Moving the IRA? It Depends

Some IRA custodians cannot make a postdeath distribution directly from the decedent’s account and report it under the beneficiary’s TIN. Therefore, they require the beneficiary to establish a beneficiary IRA, move the assets from the decedent’s IRA to the beneficiary IRA, and then take any remaining year-of-death RMD from the beneficiary IRA.

Other custodians can distribute the remaining year-of-death RMD from the decedent’s IRA and report it under the beneficiary’s TIN.

Either approach can work, as long as the tax reporting for the post-death distribution is done under the beneficiary’s name and TIN.

Key Rule: A year-of-death RMD that the decedent did not take may be distributed to a beneficiary before or after the transfer, depending on the custodian’s procedures.

Example: IRA-to-IRA Transfer

Maria died at age 82, and her son Kyle inherited her traditional IRA. Her RMD for the year was $20,000, but she had withdrawn only $8,000 before her death.

Custodian A might require Kyle to establish a beneficiary IRA, transfer his inherited share to that IRA, and then distribute the remaining $12,000 RMD to him.

Custodian B might distribute the $12,000 to Kyle from Maria’s IRA and then transfer the remaining balance to Kyle’s beneficiary IRA.

Either procedure can produce the correct result if the $12,000 distribution is reported to Kyle.

Some custodians, typically IRA annuity providers, may retain the assets under the decedent’s IRA contract rather than establish a separate beneficiary IRA, while reporting postdeath distributions under the beneficiary’s name and TIN.

But Is a Year-of-Death RMD Actually Due?

Before applying these procedures, you need to determine whether the IRA owner had an RMD for the year of death. First, find out whether the IRA owner died before or on/after the required beginning date.

For a traditional IRA owner, the RBD is April 1 of the year after the year in which the owner reaches the applicable RMD age. The applicable RMD age depends on the owner’s date of birth and ranges from age 70½ to 75. See my article, “IRS Finalizes RMD Regulations: Key Takeaways and the 10-Year Rule for Beneficiaries.”

Reminder: A Roth IRA owner is treated as having died before the required beginning date because a Roth IRA owner is not required to take lifetime RMDs.

Death Before the Required Beginning Date

If the IRA owner died before the RBD, there is no year-of-death RMD for the beneficiary to take. That does not necessarily mean the beneficiary will have no RMDs in later years. Those requirements depend on the beneficiary’s classification and the applicable distribution rules after death.

Death On or After the Required Beginning Date

If the IRA owner died on or after the required beginning date, an RMD is due for the year of death. If the owner died before taking the full amount, the undistributed balance must be paid to their beneficiary.

Although the amount is calculated as part of the deceased owner’s RMD, the postdeath distribution is made to the beneficiary and reported under that beneficiary’s TIN. It is not included as income on the deceased owner’s final income tax return.

This reporting requirement is at the heart of the confusion about whether an RMD must be taken before or after a beneficiary IRA is established.

The Custodian’s Operational Procedure Drives What You Must Do

Different procedures do not necessarily mean that one custodian is wrong, but you want to be careful to avoid requesting a distribution when that is not your intent.

Before authorizing the transaction, make sure you know:

1. Is any portion of the decedent’s year-of-death RMD still outstanding?
2. Is a separate postdeath RMD required of the beneficiary for the year?
3. Does the custodian require the outstanding year-of-death RMD to be distributed before or after transferring the inherited assets?

The beneficiary’s job is to make sure the inherited status is preserved when required or desired, the correct recipient receives the Form 1099-R, and every required distribution is completed by the applicable deadline.

Next month, I will detail the rules that apply when the inherited account is an employer-sponsored plan, such as a 401(k), rather than an IRA.