by Josh Stelzer, CFP®
I think we all have a pretty solid understanding of how IRA’s work. We know there are annual contribution limits, income level restrictions and different tax treatments for the distributions during retirement, but what happens to these IRA’s when one passes away? There are several important rules that come into play depending on who was designated to be the beneficiary of the account, and what their relationship was to the deceased account owner.
Spousal Beneficiaries
As the spouse of a deceased account owner, you may elect to be treated as the owner of the account, and not the beneficiary. What does this mean for you? By electing the “owner treatment”, you can roll the funds into your own IRA account, which will allow you to calculate the required minimum distribution based on your age in the years moving forward. This can be beneficial if your spouse was older than you and hadn’t yet begun his or her required minimum distributions.
Reversing the situation, you may also keep the IRA in your deceased spouse’s name as an “Inherited IRA”, and elect to have the required minimum distributions based on your deceased spouse’s age.
Why would you do this? Well for example, let’s say your decedent spouse is actually younger than you. You wouldn’t want to take the assets in your name because you would be forced to take the required distributions in the year that you turn 70 ½. By leaving them in the younger decedent spouses name, you will not have to take your required minimum distributions until the younger deceased spouse would have turned 70 ½, had he or she still been alive. This can allow for several additional years of tax-deferred growth!
Non-Spousal Beneficiaries
Listing a non-spouse as your beneficiary has different rules than those who are spouses. These rules are dependent on whether or not the deceased individual had reached their Required Minimum Distribution
Death before the required minimum distribution date of the deceased:
If this is the case, you have the option of taking the required distributions in one of two ways:
1. Life Expectancy Method – This method requires you to withdraw certain minimum amounts annually according to calculations listed in Publication 590 of the Internal Revenue Code. These withdrawals will be based on your life expectancy. In order to take advantage of this method, you must make your first Required Minimum Distribution by December 31st of the year following the original account holder’s death. Important Note: If you fail to make this distribution, you will automatically be required to follow the Five Year Method outlined below.
2. The Five-Year Method – This method will require you to withdraw all of the assets no later than the end of the fifth year following the original account owner’s death. There are no minimum amounts to withdraw each year; you simply must have all of the assets withdrawn before the 5 year deadline.
Death on or after the required minimum distribution date of the deceased:
If the decedent died on or after reaching their 70 ½ birthday, you are not allowed to use the five-year method. You are restricted to using the life expectancy method, which requires you to withdraw at least the minimum amount each year. It is also important to note that if the decedent had not yet taken their first RMD, you must take the first distribution by the end of the year the decedent passed away.
As you can see this can be a confusing time for those who inherit a loved one’s retirement account. It is very important to consult with a qualified professional when making these decisions so that you can rest assured you are making the right decision.
Not following the rules set forth by the IRS can result in extremely steep penalties, which are easily avoided with proper planning. We are always happy to have these discussions with you and offer our guidance, so that you may maximize the benefits allotted in inherited retirement accounts. You may request a free consultation by clicking here or calling us at 1-888-6SNIDER.
