Cascading IRA beneficiaries.

• Author: Lange, James

EXECUTIVE SUMMARY

* A cascading beneficiary plan allows a surviving spouse to roll over an inherited IRA into his or her own IRA and stretch RMDs over a longer period.

* Naming a younger beneficiary results in lower RMDs.

* A surviving spouse can disclaim all or part of an interest in an inherited IRA and allow it to pass to younger contingent beneficiaries.

Most taxpayers would dramatically improve their family's finances by using savings and investment strategies that defer taxes. Capitalizing on this idea provides the basis for successfully accumulating and distributing retirement assets and lays the foundation for optimal estate planning for owners of IRAs and Secs. 403(b) and 401(k) plans, etc, (collectively, "IRAs"). This article examines a cascading beneficiary plan, which offers a particularly flexible strategy based on combining "stretch" IRAs and disclaimers.

"Stretching" an IRA

Spousal Beneficiary

If a surviving spouse is an IRA beneficiary, it is generally best for the surviving spouse to roll the IRA into his or her own IRA. The surviving spouse will not be required to take required minimum distributions (RMDs) until April 1 of the year following the year the surviving spouse turns 70 1/2. The surviving spouse's RMDs from the IRA will be based on the joint life expectancy of the surviving spouse and someone who is deemed to be 10 years younger than the surviving spouse. (1) For example, if the surviving spouse is 71 years old, he or she has a life expectancy of 16.3 years and his or her beneficiary (deemed to be 61) would have a life expectancy of 16.3 years under the Single Life Table in Regs. Sec. 1.401(a)(9)-9. (2) The RMD for the surviving spouse's rollover is based on a joint life expectancy of 26.5 years, found under the surviving spouse's age in the Uniform Lifetime Table in Regs. Sec. 401(a)(9)-9, Q&A-2. For the following year, the RMD would be based on a distribution period of 25.6 years.

If the surviving spouse did not roll over the IRA or elect to be treated as its owner, and the IRA owner died before distributions began, the RMD will be based on the surviving spouse's single life expectancy, resulting in a shorter distribution period and a larger RMD.

Young Surviving Spouse

There are exceptions to the general recommendation that a beneficiary spouse roll an IRA over into his or her own IRA. For example, it is not prudent to roll over the inherited IRA if the surviving spouse is younger than 59 1/2 and needs income from the IRA, because withdrawals from the rollover IRA would be subject to the Sec. 72(t) 10% penalty for pre-age 59 1/2 distributions. If, however, the IRA remains as the decedent's IRA, the surviving spouse can take distributions without the 10% penalty under Sec. 72(t)(2)(A)(ii). (3) Alternatively, a young surviving spouse could roll over a portion of the IRA into his or her own IRA, and treat the rest of it as an inherited IRA not subject to a penalty for withdrawals either before or after age 59 1/2.

Nonspousal Beneficiary

Under Regs. Sec. 1.401(a)(9)-5, Q&A-5(c), a nonspousal beneficiary's RMD is based on the beneficiary's life expectancy as of December 31 of the year following the year the IRA owner died. For example, if the beneficiary is the IRA owner's 45-year-old child, he or she would have a deemed life expectancy of 38.8 years under the Single Life Table. The RMD for the inherited IRA would be calculated by dividing the balance in the account as of December 31 of the year the IRA owner died by the beneficiary's life expectancy. For a $1 million balance, the RMD will be $1 million divided by 38.8 or $25,773. As the beneficiary ages, the life expectancy is reduced by one year (i.e., the next year's factor would be 37.8, then 36.8, etc.). (4) The RMDs for Roth IRA beneficiaries follow the same rules, but the distributions are income tax free.

Naming a...