Unlikely as it may seem, there are some beneficiaries who prefer not to receive inherited assets. The reasons vary: often the beneficiary would like the assets to be given to someone else; other times the original beneficiary does not want to be taxed on the assets. A beneficiary who properly disclaims inherited assets is treated as if he or she never was the designated beneficiary. (For more, see Mistakes In Designating A Retirement Beneficiary.)
TUTORIAL: Personal Income Tax Guide
If you are considering disclaiming an IRA or other inherited retirement plan, you need to understand the effect of your disclaimer and the procedure you must follow to ensure that your disclaimer is considered qualified under federal and state law.
Reasons for Disclaiming Inherited Assets
If a beneficiary properly disclaims inherited retirement assets, his or her status as beneficiary is fully annulled. This individual, therefore, will not owe federal or estate taxes on the assets. Instead, the successor beneficiary will be responsible for paying any taxes due on the amount.
Disclaiming inherited assets is not only for avoiding taxes. In some instances, beneficiaries disclaim assets so that other certain individuals receive the assets. The beneficiary disclaiming the assets, however, must be aware of the effect of the disclaimer, especially if the intention is to have a particular individual become the successor beneficiary. (Read more, in Designating A Trust As Retirement Beneficiary.)
Without naming any contingent beneficiaries for his IRA, John, a widower, designates his son, Tim, as the sole beneficiary the IRA. In his will, John also assigns a substantial amount of money from his estate to Tim. A few months after naming Tim as his beneficiary, John remarries, but dies a few years later. John never got around to updating his beneficiary designation to include his new wife, Mary. From conversations they had prior to John's death, Tim knows that John wanted to leave the IRA to Mary. Upon consulting the IRA custodian, Tim learns that the IRA document has a default provision for beneficiary designations. This default provides that if the IRA owner failed to designate a beneficiary, the IRA owner's spouse is the designated beneficiary. Tim, therefore, properly disclaims the IRA assets and is now treated as if he never was the designated beneficiary. Mary, by virtue of the default provision of the IRA plan document, becomes the beneficiary of the IRA.
It is important to note that if John designated a contingent beneficiary, that individual (or entity), rather than Mary, would become the successor beneficiary. The default provision of the plan document comes into effect only if no beneficiary was designated for the IRA; furthermore, not all IRA plan documents have this default option. For instance, plans may default to the estate of the deceased. (For further reading, see Designating A Minor As An IRA Beneficiary.)
A beneficiary may choose to disclaim only a percentage of the inherited assets. This is acceptable if the disclaimer meets the certain requirements. A disclaimer that does not meet basic requirements under federal and state law could cause adverse consequences for the person disclaiming the assets and any individuals who are beneficiaries as a result of the disclaimer. The following are the requirements that must be met for a disclaimer to be qualified:
- The beneficiary must provide an irrevocable and unqualified refusal to accept the assets.
- The refusal must be is in writing.
- The document must be submitted to the retirement account custodial at the later of the following times:
- Nine months after the retirement account owner dies.
- Nine months after the beneficiary attains age 21 if he or she is 21 when the retirement account owner dies.
- The beneficiary must not have accepted any of the inherited assets prior to the disclaimer.
- The assets must pass to the successor beneficiary without any direction on the part of the person making the disclaimer.
Some states require the disclaimer to include a particular statement that says the person disclaiming the assets is not subjected to any bankruptcy proceedings. Anyone disclaiming assets should seek legal advice on the laws of his or her state of residence.
Final Thoughts - Documentation
There is no special form or document that an individual must complete to disclaim inherited assets. A letter usually suffices, providing it meets the above requirements. To ensure that any special requests are honored by the custodian/trustee of the retirement account, an individual disclaiming assets should check with the custodian/trustee regarding the manner in which these requests should be handled.
Talk to your tax professional to find out under what circumstances tax consequences could arise when disclaiming inherited assets. These may not apply to you, but they may apply to the successor beneficiary.
Some disclaimers may require court approval if, for instance, the individual disclaiming the assets is mentally incapacitated or a minor. Beneficiaries who are considering disclaiming assets must seek legal advice to ensure their disclaimers meet federal and state requirements. (For more information, see Gifting Your Retirement Assets To Charity.)
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