Required minimum distribution alternatives for IRA beneficiaries.

• Author: Burilovich, Linda
• Position: Individual retirement account

The owner of a traditional IRA is required to withdraw a minimum amount from the account each year after reaching age 70 1/2. If the owner dies before the complete withdrawal of assets from the IRA, several options are available to beneficiaries regarding the timing of future distributions. Post-death distributions made to beneficiaries are subject to the general income tax treatment of all IRA distributions, with nondeductible contributions withdrawn tax free and all other amounts subject to tax as ordinary income under the annuity rules of Sec. 72. In light of these tax consequences, many beneficiaries will prefer to maximize the deferral period for receiving taxable IRA distributions.

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The options available for deferring post-death distributions depend on the IRA plan rules, the beneficiary's relationship to the deceased owner, and whether death occurred before or after the date the owner was required to begin receiving distributions from the IRA. These factors affect both the starting date and the amount of required minimum distributions (RMDs) following the IRA owner's death. While the selection of a plan and beneficiary should be part of the owner's estate planning before death, strategic postmortem planning also requires careful consideration of alternative distribution options available to beneficiaries. In many cases timely action is necessary to avoid unexpected and unnecessary tax costs. This article discusses the distribution options available to IRA beneficiaries, with an emphasis on opportunities to control the timing of the distribution period and actions that must be taken on a timely basis to achieve the desired outcome.

RMDs in General

Sec. 401(a)(9) mandates that on or before the IRA owner's required beginning date, the entire account balance must be (1) distributed in full, (2) distributed over the actual life of the owner or the actual joint lives of the owner and a designated beneficiary, or (3) distributed over the life expectancy of the owner or the joint life expectancy of the owner and a designated beneficiary. The required beginning date is April 1 of the year following the calendar year in which the IRA owner attains age 70 1/2. (1) For all subsequent years, the minimum distribution must be made by December 31 of that year. Unlike certain qualified plan participants, IRA owners cannot delay distributions beyond the required beginning date because they continue to be employed. (2)

For each calendar year, beginning with the required beginning date, the minimum distribution is calculated by dividing the December 31 account balance (from the preceding year) by the remaining life expectancy of the account owner or, in some cases, the joint life expectancy of the owner and the designated beneficiary. (3) In general, the IRA owner will use the Uniform Lifetime Table to determine the life expectancy used in calculating the required distribution. (4) If the spouse is the sole beneficiary and is more than 10 years younger, the IRA owner may use their joint life expectancy from the Joint Life and Last Survivor Expectancy Table. (5) This table provides a longer distribution period by including the longer life expectancy of the younger spouse. Thus, the selection of a spouse as beneficiary may influence the lifetime distributions required of the IRA owner. (6)

The owner of multiple IRAs must calculate the minimum distribution for each account separately. These amounts may be aggregated into a total amount to be withdrawn from one or more of the IRAs. This rule does not apply to inherited IRAs, which may not be aggregated with other IRAs owned by a beneficiary. It is, however, permissible to aggregate inherited IRAs from the same decedent. (7)

The RMD provides a floor for the amount to be withdrawn for a specific tax year. The IRA owner or the beneficiary of a deceased owner always has the option of taking a lump-sum distribution or any distribution amount in excess of this minimum. If the owner or beneficiary does not withdraw the required minimum amount, however, the consequence is a penalty tax of 50% imposed on the difference between the RMD and the lesser actual distribution. (8) Proper application of the rules is important to avoid unexpected tax liabilities and penalties when maximizing the deferral of distributions.

IRA Beneficiaries

The choice of an IRA beneficiary may affect the lifetime RMDs when that choice is a spouse who is more than 10 years younger than the owner. The beneficiary selection also affects post-death distribution requirements. The effect depends on whether the beneficiary is an individual and whether that individual is a surviving spouse who is the sole beneficiary of the account.

For purposes of measuring post-death distribution requirements, a beneficiary must be a designated beneficiary. In most cases, the designated beneficiary's life expectancy will be used to determine minimum distributions from the account. A designated beneficiary is one who was a beneficiary at the date of death and remains a beneficiary as of September 30 of the year following death (the determination date). Beneficiaries may be removed during this 9- to 21-month window by issuing a disclaimer or receiving their entire share of the distribution before the determination date. If a beneficiary dies before the determination date without making a disclaimer or receiving the full benefit, he or she continues to be treated as a beneficiary (i.e., he or she is not replaced by a successor beneficiary). (9)

A designated beneficiary must be an individual and may be affirmatively named by the owner or defined under the terms of the plan. An estate or trust cannot be a beneficiary for this purpose. The designated beneficiary does not have to be identified by name but must be identifiable as of the determination date. An individual who is not a named beneficiary but inherits an interest under a will or by state law is not considered a designated beneficiary. (10)

IRA beneficiaries are divided into two categories for application of the distribution rules. A unique set of rules is available to a surviving spouse who is the sole beneficiary of the IRA with an unlimited right to withdraw funds (surviving spouse IRAs). All other beneficiaries fall into a second category with a more limited set of distribution alternatives (inherited IRAs). Within each category, the applicable distribution rules will depend on whether the...