Why Separate Accounting Is Essential After an IRA Owner Passes Away
By Agatha Schmidt, CISP, SDIP, CHSP
Handling beneficiary distributions is one of the most complex facets of administering IRAs. To help keep things as simple and straightforward as possible, separating beneficiary assets as soon as you are notified of an IRA owner’s death may help your financial organization not only ensure that beneficiaries preserve their options but also stay compliant with year-of-death reporting requirements. Failing to apply separate accounting in a timely manner may result in a beneficiary losing certain options.
What is Separate Accounting?
Separate accounting is the act of dividing the deceased IRA owner’s assets into separate portions for each beneficiary as of the date of the IRA owner’s death. This ensures that gains or losses on the assets held within the IRA are allocated properly for each beneficiary’s portion and can be properly tracked for fair market value reporting purposes.
The deadline to establish separate accounts is December 31 of the year following the year of the IRA owner’s death.
What is Required to Establish Separate Accounting?
A common misconception is that a new IRA is being opened when separate accounting occurs – this, quite simply, is not true. When assets are divided into separate portions, each beneficiary’s portion can be treated as a subaccount of the original IRA; the portions are not considered new IRAs. Think of a whole pizza representing an individual’s IRA which, upon death, gets sliced into a serving for each beneficiary. Each slice does not become a whole pizza; it is just a portion of the whole pizza that has been set aside for a beneficiary.
Each separate account is established as an inherited IRA. Because an inherited IRA is not a new IRA, a beneficiary is not required to complete opening documents. Your financial organization may, however, want to have the beneficiary complete an Inherited IRA Simplifier®, especially if the inherited assets are coming from outside the organization. This has become common practice, and this document can help capture information on both the original account owner and any named successor beneficiaries, as well as the transaction used to establish the subaccount and the beneficiary’s payment election, if more than one payment option is available.
Why is Separate Accounting Essential?
Treasury regulations stipulate that beneficiary payment options differ in some regards if accounts are not separated. When separate accounting is established timely, a spouse beneficiary who is not the sole designated beneficiary may transfer her portion of the decedent’s IRA to her own IRA. If separate accounting is not established timely, then the spouse beneficiary cannot transfer those assets, but she can take a distribution, and if eligible, roll over the assets to her own IRA.
If beneficiary accounts are recognized as separate accounts, each beneficiary is treated as a sole designated beneficiary and can use his own single life expectancy to calculate life expectancy payments, if that option is available.
Does Separate Accounting Affect Reporting Requirements?
In the year of death, financial organizations must issue fair market value reporting for the decedent and for each beneficiary who still has a balance on December 31. Separate accounting will make this reporting requirement easier to complete.
Moving assets from a decedent’s IRA to a beneficiary’s inherited IRA is simply an internal transfer of assets, which is not reported to the IRS. Once separate accounts have been established, any reporting is generated in the beneficiary’s name and Social Security number (SSN). For example, if assets remain in the beneficiary’s inherited IRA, the December 31 FMV should be reported on Form 5498 in the beneficiary’s name (as beneficiary of the IRA owner) and SSN. Distributions from the inherited IRA should be reported on Form 1099-R, Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., as a death distribution.
