What happens to an IRA without beneficiary designation?

When you establish an IRA account, you are required to name your beneficiaries in the designated beneficiary form. The beneficiary can be a spouse, child, grandchild, other relatives, or a close friend. Once you die, the named beneficiaries will inherit the IRA retirement assets. However, if there is no beneficiary designation when you die, different rules will apply.

If you leave an IRA without a designated beneficiary, your IRA assets will become part of your estate, and they will be shared out between your heirs. The IRS requires that, once an IRA is paid to an estate of the deceased, the assets must be distributed among the heirs within five years. A sizeable portion of these retirement assets will go into paying income taxes.

What happens when an IRA has designated beneficiaries?

If your IRA has designated beneficiaries when you die, the beneficiaries have multiple options to inherit the retirement assets.

If your spouse is the primary beneficiary, they can choose to transfer the assets to their IRA, spread distributions based on their life expectancy, or leave the money in the IRA and take required minimum distributions each year based on your life expectancy. If the children inherit the parent’s IRA, they can stretch distributions over a 10-year period. 

When there are designated beneficiaries, the retirement assets can be preserved for a longer time to earn interest and grow through compounding. Also, since beneficiaries only pay tax when they withdraw money from the inherited IRA, they can reduce the tax burden by spreading distributions over a longer period.

What happens when an IRA has no designated beneficiaries?

If you leave your IRA without a designated beneficiary when you die, the retirement assets are paid to your estate. Since the estate is the inheritor, there are no designated beneficiaries in the deceased’s estate, and the estate cannot stretch distributions. If you inherit an IRA through an estate, you cannot stretch distributions using your life expectancy.

IRS rules require that, if you die before reaching age 70 ½, the IRA assets paid to your estate must be distributed within five years. While your heirs will share in your IRA assets, they will likely inherit a smaller portion since a significant portion of the funds will go to income taxes. Also, by requiring the retirement assets to be paid within five years, it means your retirement will have a shorter life expectancy, and the benefits will not last a lifetime.

If the IRA owner dies after age 70 ½ and there is no designated beneficiary, the heirs of the deceased’s estate have some leeway. Though they cannot stretch distributions over their lifetime, the heirs can spread distributions over the deceased's IRA owner’s life expectancy, had he/she lived.

What happens when the primary beneficiary dies after the IRA owner?

When an IRA owner dies, the primary beneficiary inherits the assets of the deceased account holder. Most often, if the IRA owner was married, the spouse is usually the primary beneficiary.

If the primary beneficiary dies after the IRA owner, and the primary beneficiary had not named secondary beneficiaries, the IRA will go through probate before being paid to the estate. However, if the primary beneficiary had named beneficiaries in the designated beneficiary form, the named beneficiaries will inherit the remaining IRA assets.

No other person is entitled to receive the retirement assets unless the named beneficiary disclaims the assets or dies.

Estate as a beneficiary of an IRA

If the IRA does not have a designated beneficiary or the estate is listed as a beneficiary, the IRA money is first distributed to the state. The funds will go through a probate process before they are paid out to the heirs of the estate.

A probate process is a court-supervised process of reviewing the deceased’s assets and validating a will. Probate is an expensive process since the estate executor and attorney fees are charged as a percentage of the estate value.

Since the probate process is a matter of public record, there is no privacy in the distribution of assets of the deceased, and it can expose the assets to creditors. Also, distributions of the IRA assets will be subject to unfavorably high estate taxes, and a good portion of the retirement assets will go into paying taxes.

However, you can avoid a probate process by naming an individual as a beneficiary of your IRA. Once you die, the IRA assets will be paid directly to the designated beneficiary. By naming a beneficiary, you avoid losing a significant portion of your money to taxes and the money has a chance of lasting a lifetime.