After discussing contributions, withdrawals and potential tax issues in this series of articles, I have covered most of the main topics about accumulating and managing retirement assets. The remaining two topics deal with naming IRA beneficiaries – which I will cover in this article – and some final points about IRA administration and custodial issues that I will leave for the next article.
The intended function of retirement accounts is to provide income after the retirement account owner stops working. To achieve that goal, retirement account owners work on amassing enough funds to cover their living expenses for the reminder of their lives, based on their desired life style and life expectancy.
However, since these are just estimates with many unpredictable variables, some retirees will outlive their savings and investments and other retirees will pass away before exhausting their accumulated assets. In this article, I will focus on the latter case and explain what retirement account owners must do to ensure a smooth transition of their remaining assets to their designated beneficiaries.
1. When an IRA is opened, the IRA custodian usually requires that the IRA owner identify a primary beneficiary or beneficiaries.
2. The IRA custodian also will request that the IRA owner names a Secondary – or Contingent – beneficiary in the event that an IRA owner outlives the primary beneficiary or beneficiaries.
3. If the IRA owner outlives the primary beneficiary or beneficiaries and the account has not named a secondary beneficiary or beneficiaries, the full value of the IRA goes to the IRA owner’s estate.
4. If there is no designated beneficiary on the IRA document and the decedent’s will specifies a beneficiary or beneficiaries of the estate, the estate executor may designate them as the IRA beneficiaries. In that case, separate inherited IRAs may be established and the portion of the beneficiaries’ share would be transferred to the inherited IRA. Once the assets are moved to the inherited IRA, the beneficiary then may have to move those assets as a direct agent-to-agent transfer to an IRA custodian of his or her choice.
5. If the IRA owner dies before the Required Beginning Date (RBD) without designating a beneficiary to the IRA, the assets will be distributed over a period of no more than five years, according to the “Five-Year Rule.” I have explained the five-year rule in a previous article about mandatory withdrawals from IRAs at the death of the owner.
6. If the IRA owner dies after the RBD and has not designated a beneficiary to the account, the payouts from the IRA will continue at a rate that is at least equal to the payout rate that the owner was receiving prior to death and after the RBD.
7. Once an IRA is inherited, the primary IRA beneficiary usually will identify a Successor. If the designated beneficiary dies before fully depleting the inherited IRA, the successor beneficiary withdrawal rate must continue using the same life expectancy that the now-deceased primary beneficiary was using.
8. To receive a portion of an inherited IRA, multiple beneficiaries must set up individual accounts prior to Dec. 31 of the year following year of death of an IRA owner. Failure to do this results in lifetime minimum distributions at the rate of the oldest beneficiary to all the beneficiaries.
9. Some states require approval of the spouse to name beneficiaries other than the spouse for IRA inheritance. The Employee Retirement Income Security Act of 1974 (ERISA) regulations control Employer retirement plans and require that the spouse approve any beneficiary other than himself/herself.
10. A disclaimer by a beneficiary will direct her inherited portion of the IRA to the contingent beneficiary or, if none are named, into the estate. The disclaiming beneficiary may not direct who the contingent beneficiary will be or may not make any other condition on the disclaimed amount. Disclaimed amounts are not included in the estate of the disclaiming beneficiary.
11. A trust may be named as the beneficiary if it meets the following conditions:
a. The trust may be a Pass Through or an Accumulation Trust and in compliance with the trust laws of the state of residence of the IRA owner.
b. Generally, a trust is the best choice when the IRA owner does not wish the named beneficiary to have full and immediate access to the inherited IRA balance.
c. The designated trustee must establish the trust and its IRA beneficiary not later than Oct. 31 of the year following the year of death of the IRA owner.
12. If more than one person is named as a beneficiary to the decedent’s IRA and separate inherited IRAs are not created by the end of the year – Dec. 31 – following the year of death, the life expectancy of the oldest beneficiary determines the minimum annual distribution for all beneficiaries.
13. If any of the named beneficiaries are non-persons and separate accounts have not been established by December 31 of the year following the year of death, the IRA minimum distribution rules will follow those of a non-person.
Unlike some of the other IRA topics, naming beneficiaries is not very complicated and draws on a lot of rules and requirements that I already discussed in previous articles on this topic. However, I will share in my next article a few answers to some customer questions to show how IRA owners and beneficiaries should handle some common real-life situations.
Bruce Miller is a certified financial planner (CFP) who also is the author of Retirement Investing for INCOME ONLY: How to invest for reliable income in Retirement ONLY from Dividends and IRA Quick Reference Guide.