For most people, choosing who will inherit their IRA at their death is a quick decision that’s usually made when their IRA account is first opened. As the years pass by, most people don’t give it another thought. Because life can take some unexpected turns, it’s important to keep beneficiary information updated and revisit it from time to time. By carefully choosing your beneficiary, you can provide for your loved ones for many years to come and make plans to reduce the related tax burden of IRA distributions.
When determining who the IRA beneficiary should be, it’s important to remember that distributions from IRA accounts are taxable to the extent that they exceed basis in the account. Prolonging taxable distributions and spreading them out over multiple years may help decrease the income tax burden for beneficiaries. When the IRA owner dies, the distribution requirements depend on the age of the IRA owner at death and who is named as the beneficiary. There are three classes of beneficiaries:
- Eligible designated beneficiary (EDB) – subject to life expectancy payout method
- Designated beneficiary (DB) – subject to a 10-year rule
- Beneficiary that is not designated – subject to a five-year rule
The following are EDBs:
Surviving Spouse as the Sole Beneficiary
When an IRA owner dies before the date when they must take required distributions and has named their spouse as the beneficiary, the surviving spouse can assume the IRA as if it’s their own and delay distributions until they reach the age of 72 (age 70 ½ if born before July 1, 1949). The IRA is treated as if it were the surviving spouse’s own IRA and required minimum distributions (RMDs) are based on the surviving spouse’s life expectancy. If the surviving spouse is older than the decedent, they may choose to leave the IRA as an inherited IRA and take RMDs based on the date the decedent would have been required to begin taking them.
Minor Children as Beneficiaries
If the IRA owner died before the required beginning date (RBD), the RMD for years after the owner’s death is calculated using the minor’s life expectancy. When the minor child reaches the age of majority, then a 10-year distribution period begins (the child ceases to qualify as an EDB at this time). All IRA funds must then be distributed by December 31 of the year containing the 10th anniversary of the child reaching the age of 21.
Disabled Individuals or Chronically Ill Individuals
Disabled or chronically ill beneficiaries also receive special treatment as EDBs. If an individual is determined to be disabled for Social Security within the meaning of 42 U.S.C. Section 1382c(a)(3), they will be treated as disabled for these IRA rules. If the IRA owner died before the RBD, the RMD for years after the owner’s death is calculated using the disabled or chronically ill individual’s life expectancy. EDBs in this category can use the longer of their single life expectancy or the owner’s life expectancy.
Individuals Who Are Not More than 10 Years Younger than the IRA Owner
People who are not more than 10 years younger than the IRA owner also are considered to be EDBs who qualify to use their life expectancy when calculating the RMD.
The following are DBs:
Children & Other Individuals Who Are Not EDBs
A 10-year distribution rule applies to individuals who don’t meet the qualifications to be an EDB. Distributions must be completed within 10 years of the IRA owner’s death when the designated beneficiary is not an EDB. If the IRA owner died after their RBD, the annual RMDs must be taken using the greater of the decedent’s or the DB’s life expectancy.
If a trust meets all the requirements to be treated as a DB, the trustee can look to the trust beneficiaries to determine the proper period for the RMDs. The trust must be a valid trust under state law, must be irrevocable upon the IRA owner’s death, must name individuals as trust beneficiaries, and must provide for the trust instrument to be provided to the IRA administrator by October 31 of the year following the IRA owner’s death. The trust must receive the RMD and pass it on to the income beneficiaries. This type of trust can be set up for a minor child or the surviving spouse to take advantage of the special rules for EDBs. If the beneficiary is not an EDB, the trust beneficiary must receive distribution of all the IRA funds by December 31 of the year containing the 10th anniversary of the owner’s death.
An accumulation trust can be established for an EDB as the sole beneficiary. If the trust is for a disabled or chronically ill individual, it may receive RMDs based on the disabled or chronically ill individual’s life expectancy. An accumulation trust for a minor child would not qualify for the RMD based on life expectancy but would instead be required to use the 10-year distribution rule.
If a beneficiary is not named or if an estate, a charity, or a trust that does not qualify as a see-through trust has been named as the beneficiary of the IRA, a five-year rule applies. All IRA funds must be distributed by December 31 of the year containing the fifth anniversary of the owner’s death. Failure to do so can subject the remaining IRA funds to a 50% excise tax.
The IRA beneficiary rules noted above apply to Traditional IRAs and Roth IRAs. The difference with the Roth IRA is that RMDs would not be required, but the accounts are still required to be distributed under the beneficiary rules.
Careful consideration should be made when designating your IRA beneficiary. This is important for those even without a taxable estate—it’s important for anyone lucky enough to have an IRA. Take time today to review your beneficiary designation forms and preserve your legacy.
If you have any questions or need assistance, please reach out to a professional at FORVIS or submit the Contact Us form below.