03/09/2023
Have You Reviewed Your IRA Beneficiaries?
For most people, choosing who will inherit an IRA at their death, is a quick decision that’s usually made when the account is first opened. There is a good chance you opened an account years ago and haven’t given it much thought since. Unfortunately, we know that life can take some unexpected turns, so it’s important to keep beneficiary information updated and revisit it from time to time. Also, remember that IRA beneficiary designations supersede a will, so even if your will has been updated, your IRA beneficiaries may not be current. By carefully choosing your beneficiary, you can provide for your loved ones for many years and make plans to reduce the related tax burden of IRA distributions. This became even more important when the SECURE Act eliminated “Stretch” IRAs, so now inherited IRAs with non-spouse beneficiaries (i.e. children or grandchildren) have different guidelines. The SECURE Act distinguishes between designated beneficiaries and other beneficiaries who inherit an IRA. These rules apply for individuals with account who die after December 31, 2019. Read below to understand how beneficiaries are designated for IRAs and how the payout varies for each:
Eligible Designated Beneficiary (EDB)
Only designated beneficiaries can take distributions over their life expectancy from IRAs. Therefore, if a beneficiary does not fall into the criteria below, they are required to receive a full distribution of the assets in the inherited account by the end of the tenth year after the account owner's death. EDBs are:
- A 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 73. 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.
- A minor child (under 18) - 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.
- A disabled individual,
- A chronically ill individual, or
- An individual who is not more than ten years younger than the account owner
The following are not EDBs and are considered Designated Beneficiaries (DBs):
- Adult children without disabilities
- Trusts, estates, charities
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.
What if a beneficiary is not named, or if an estate, charity, or a trust does not qualify to be named as a beneficiary? They would be subject to a five-year rule. 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.
These rules apply to traditional and Roth IRAs, although RMDs would not be required for Roth IRAs, but the account is still required to be distributed under the beneficiary rules. Here is a detailed inherited IRA roadmap to help you navigate inherited IRAs.
Talk to Us!
If you are the owner of an IRA, or the inheritor, you may want to take some time to consider how the changes made by the original SECURE Act may impact your beneficiary designations. Remember, your retirement plans should evolve just like you do! Keeping your estate plan up to date is just as important as creating it.
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