The Wealth & Wisdom Blog

In previous generations, grandchildren might have inherited a dinner plate, a piece of artwork, or jewelry from grandma and grandpa. But given the current costs of post-secondary education and home ownership, more young adult beneficiaries are seeking to receive a financial inheritance from their grandparents in lieu of a sentimental inheritance.  For many of our client families, the parents of these grandchildren are looking for a way to shift the income tax burden on inherited individual retirement account assets to the next generation.

In this month’s update, I briefly outline key elements of how a grandmother or grandfather’s retirement account might be allocated to lower-earning family members (e.g., grandchildren) to lower the collective income tax burden.

Income Taxes on Inherited IRA Assets

Upon the death of the original traditional IRA account owner, the new owners of the inherited traditional IRA are subject to income taxes.  In general, adult children and grandchildren have up to 10 years to withdraw remaining inherited IRA assets.¹   As the new owners of the inherited IRA withdraw assets, the new owner(s) pay ordinary income taxes at his or her personal income tax rate.²  In many cases, the child of the original account owner (“daughter”) is at higher income tax rate then her child (“grandson.”)  The family may decide to earmark grandmother’s traditional IRA assets to grandson through one of two ways, both of which require careful planning.³

Grandma’s Beneficiary Designations During Lifetime

First, Grandma may designate grandson directly as primary beneficiary of the traditional IRA account.  Grandson would then have 10 years to withdraw inherited assets, and pay taxes at his personal income tax rate.

Second, Grandma may designate daughter as primary beneficiary, and grandson as contingent beneficiary.  Following Grandma’s death, daughter can then “disclaim” some or all of the assets, thereby making grandson the new owner.  For this planning to succeed, Grandma must designate a contingent beneficiary of the IRA account during her lifetime.  Otherwise, if there was no named contingent beneficiary, Grandma’s estate would be legally considered the owner of the disclaimed assets, and the IRA account would be distributed in its entirety in the year following death.⁴

Steps for Disclaiming the IRA

The daughter must following the following requirements to disclaim the inherited IRA:

• Before disclaiming, the daughter did not take ownership of the account;
• The IRA account assets are specifically disclaimed in a written, irrevocable disclaimer;
• The daughter has not or will not receive compensation for disclaiming;
• The daughter was not in bankruptcy; and
• The disclaimer document was signed by daughter within nine months of grandma’s death.⁵

All of this maneuvering of retirement account assets makes the inheritance of Grandma’s dinner plate a piece of cake.  However, to the extent that you and your clients have the willingness and capacity to take it on, Veritage Law Group is ready and able to help with the implementation.

¹ Beneficiaries who qualify as “Eligible Beneficiaries” are permitted to “stretch” RMDs based on the beneficiary’s own life expectancy.  In addition to a surviving spouse, “Eligible Beneficiaries” include minor children, disabled and chronically ill beneficiaries, and named beneficiaries who are less than 10 years younger than the account owner.  Otherwise, all other individual beneficiaries, including adult children and grandchildren, have a 10-year time window.

² If a trust becomes the new owner at death, then the trust income tax rates apply to the RMDs after the account owner’s death.  The RMD schedule for the trust will depend on the terms of the trust.

³ This strategy is based on the important assumption that the grandchildren hold sufficient financial stewardship capabilities.

⁴  An estate has a 0 life expectancy under the life expectancy tables.

⁵ The Minnesota rules governing valid legal disclaimers can be found here:   https://www.revisor.mn.gov/statutes/cite/524.2-1101