Action Might Be Needed in 2020 to Preserve Designated Beneficiary Options for 2019 Beneficiaries
If a designated beneficiary is the sole primary beneficiary of an IRA, and the IRA agreement defaults to the life expectancy option, then the life expectancy option is automatically preserved. But, if that is not the case, there are factors that could limit the designated beneficiary’s options. The good news is, for 2019 beneficiaries, these limitations can be overridden if the appropriate action is taken in 2020. The following is a high-level explanation of these limitations and how they can be overridden.
1. Limitation1:When There Are Multiple Designated Beneficiaries
If there are multiple designated beneficiaries of an IRA, the life expectancy of the oldest beneficiary is used for beneficiary RMD purposes. This puts younger beneficiaries at a disadvantage, as it forces them to take larger RMD amounts which depletes the account faster than if they were eligible to use their own life expectancies; thus, reducing the period over which eligible amounts may continue to grow tax-deferred.
Solution for 2019 beneficiaries: Perform separate accounting by December 31, 2020
If separate accounting occurs by December 31 of the year following the year of the account owner’s death, eachdesignated beneficiary may use his own life expectancy.
2. Limitation 2: When There Are Multiple Beneficiaries That Include Individuals and Nonpersons
If there are multiple beneficiaries of an IRA, and a nonperson is one of the beneficiaries, the account is treated as not having a designated beneficiary (except for certain trusts). This would require the inherited IRA to be distributed under the 5-year rule if the owner died before the RBD and over the remaining life expectancy of the decedent, if death occurred on/after the RBD. For Roth IRAs, the 5-year rule would apply regardless of the age of the owner at death.
Solution for 2019 beneficiaries: Have nonperson beneficiaries take full distributions of their share by September 30, 2020
The determination of whether a retirement account has a designated beneficiary is made by September 30 of the year that follows the year in which the retirement account owner dies. Any beneficiary that takes a full distribution or makes a full disclaimer of that beneficiary’s share by this September 30th date, is disregarded for purposes of determining the period over which beneficiaries may take distributions. Reminder: Disclaimers must meet the requirements of IRC § 2518
3. Limitation 3: IRA Agreement Defaults to the 5-Year Rule
When a designated beneficiary inherits an IRA from an owner who died before 2020 and death occurred before the RBD, the options are the life expectancy rule and the 5-year rule. For a Roth IRA, the options are the same regardless of the age of the account owner at the time of death.
However, while the regulations and the tax code default to the life expectancy rule, an IRA agreement may default to the 5-year rule.
Solution: Override 5-year rule by making an election or moving the account by December 31, 2020
Much ado is made about the changes to beneficiary options made by the SECURE Act- and rightfully so, as they limit the distribution period to the new 10-year rule for many designated beneficiaries. But, for those who inherited retirement accounts in 2019, there are still opportunities to take distributions under the life expectancy method. When consulting with beneficiaries, advisors must determine whether the account was inherited before 2020, as that drives the distribution options.
This article was prepared by Appleby Retirement Consulting, Inc., and provided solely for informational purposes, and should not be regarded as a complete analysis of the subjects discussed, or construed as personalized legal or tax advice. Before making any decisions with legal or tax ramifications, you should consult, as appropriate, with an attorney or accountant. The information is subject to change without prior notice.