Unlike lifetime RMD distributions, after-death RMD distributions depend on the identity of the beneficiary(s) of the 401k participant.[1] Currently, retirement account owners can name their children or grandchildren beneficiaries and these young heirs can stretch out withdrawals over their own projected lifespans, enjoying potentially decades of extra tax deferred growth. This stretch planning has become a staple of planning for the affluent.
However, momentum has been gaining over a proposal first floated in 2012 by the Senate Finance Committee Chairman which would require most retirement accounts inherited by anyone other than a 401k participant spouse and certain disabled individuals to be distributed within five years of the owner’s death. Disabled heirs would still be able to stretch out withdrawals over their life spans and spouses would continue to have flexibility, including the ability to roll the account until they themselves turn 70 ½.
It’s estimated that placing a limit on the stretch strategy will raise approximately $4.6 billion in revenue over 10 years. Of course, the projected revenue increase is due to the fact that the heirs (who are likely to be in their 50’s and 60’s) won’t be able to spread out withdrawals, meaning they are more likely to be pushed into higher tax brackets at a time when the heirs are often at their highest career income.
The limit on stretch has also appeared in several of President Obama’s budget proposals, Representative Camp’s Tax Reform proposal and in nonpartisan proposals for tax simplification, raising the likelihood that it will eventually happen. So, if limits on stretch are possible in the near future what should financial representatives be doing now? At a minimum financial representatives need to understand how the RMD rules work today so they will be in position to discuss the impact changes will make on their clients’ estate plans if the proposals do get enacted into law. In this article we will address the after-death distribution aspects of the RMD rules. In addition, we will describe a couple of planning ideas that financial representatives might consider for their clients.
The rules that apply after death depend on whether the owner/participant died before or after the “required beginning date” and on the identity of the “designated beneficiary(s).” So an understanding of the after-death RMD rules must first start with an understanding of the terms “required beginning date” and “designated beneficiary.”
Required Beginning Date. The required beginning date for after-death RMDs is the same as lifetime RMDs. Specifically, for IRA owners and employees who are more than 5% owners of the employer sponsoring the plan the required beginning date is April 1 of the year after the year the owner reaches age 70½. For other qualified plan participants (non-5% owners) and 403(b) participants, the required beginning date is typically April 1 of year after the later of (a) the year the participant reaches age 70½ or (b) the year the participant retires.
Designated Beneficiary. A designated beneficiary is generally an individual named as beneficiary of an IRA or retirement account as of the “determination date.” If one or more beneficiaries is an estate, charity or nonqualifying trust[1] as of the determination date, the minimum distribution requirements will apply as if there is NO designated beneficiary. This means that no individual can be a designated beneficiary. The impact of not having a designated beneficiary is discussed later in this article.
The identity of the 401k participant beneficiaries of a decedent’s IRA or qualified plan is determined on the “determination date” which is September 30 of the year after the year of death. No new beneficiaries can be added after the account owner’s death, but it may be possible to remove “undesirable” beneficiaries (those that could shorten the payout period for other beneficiaries, such as an older beneficiary or a charity) either by paying out their interest prior to the September 30 deadline or by the beneficiary executing a valid disclaimer. Note that the deadline for a valid disclaimer is nine months after the date of death.
Now that the basic terminology is clear it’s possible to begin our discussion of the after-death RMD rules. First, we will describe the payout options typically provided by individual account plans. (Note: Defined benefit plans and amounts payable as an annuity are subject to different minimum distribution calculations.) This will be followed by a discussion of the RMD options based on the identity of the beneficiary.
RMD for Year of Death. The obvious place to start is with an understanding of the RMDs in the year of the IRA owner/plan participant’s death. The beneficiary of an IRA or plan account is not required to begin receiving RMDs in the year of the decedent’s death; however, a distribution is required in that year to the extent that the decedent had not yet taken all of his or her RMD in the year death occurred. In the year of the participant’s death RMD is based on the participant’s age in year of death and factor in the Uniform Lifetime Table. The beneficiary of the account must receive this distribution. If there are multiple beneficiaries, any one of them may take it.
Description of Typical Payout Options. Beneficiaries may have several payout options, depending on their status and the age of the participant/owner at death. The discussion that follows is based on the Internal Revenue Code, regulatory requirements, and typical plan provisions; however, not all qualified plans allow all options. The plan document should be reviewed for the specific provisions of a particular plan. Following are description of some of the typical options.
Lump Sum Payout. Typically a 401k participant beneficiary has the option to receive a payout of the entire account balance regardless of the age of the IRA owner/plan participant at death. This option is the least favorable from an income tax standpoint, since the entire distribution is generally taxed in the year of distribution as ordinary income. A distribution in this manner must be completed by December 31 of the year after the year of the decedent’s death.
5-Year Payout. If the decedent died BEFORE his or her required beginning date, the beneficiary typically has the option to choose a distribution under the 5-year rule. Under this option, no minimum distribution applies each of the first four years, but the entire account must be distributed by December 31 of the fifth year after the year of the decedent’s death.
The 5-year rule is NOT available if the decedent died on or after his or her required beginning date. In that event, the distribution period is the remaining life expectancy of the decedent (using the Single Life Table) based on his or her age in the year of death reduced by one for each subsequent year. Distributions under this rule must begin by December 31 of the year after the year of death.
Life Expectancy of Beneficiary Payout/ “Stretch” Payout. If certain requirements are met, the “designated beneficiary” of an IRA or qualified plan may elect to receive payments over his or her life expectancy. This is sometimes referred to as a “stretch” payout. A life expectancy payout election is not an obligation to delay distributions, but instead is an election to keep the life payout option available and minimize the required distribution each year. A participant always has the option to receive more than the minimum. In order to “stretch” distributions over his or her lifetime, the beneficiary must be a “designated beneficiary” and must begin distributions by December 31 of the year after the year of the decedent’s death.
The amount of the beneficiary’s distribution is determined by dividing the account balance as of the end of the preceding year by the beneficiary’s life expectancy, determined as of his or her birthday in the year for which the distribution is required. Life expectancies for this purpose are taken from the Single Life Table.
Rollover Elections of Spouse and Nonspouse Beneficiaries. While the rollover election is not per say a payout option it can have a direct impact on a beneficiary’s distribution. For example, many qualified plans do not offer a life expectancy of beneficiary payout directly from the plan. To get a payout option not offered by a plan the beneficiary must rollover the funds to an IRA. Both surviving spouse and nonspouse beneficiaries have the right to rollover qualified funds, but the rollover rights and RMD results of each is very different.
If the sole beneficiary is the surviving spouse of the owner/participant, he or she roll the funds over to the surviving spouse’s own IRA (Spousal Rollover). Where the surviving spouse elects to do a spousal rollover, he or she can name a new beneficiary and delay distributions until his or her own required beginning date. The account will become subject to new minimum distribution requirements based on the surviving spouse as owner and life expectancy.[2]
Before the rollover can be made, any RMD due as of the year of rollover must first be made. This is because required minimum distributions can never be rolled over. If it is the year of the decedent’s death and the decedent had not received his/her minimum distribution prior to death, that distribution must be made before the rollover. If it is any year after the year of death, any RMD due to the beneficiary must be paid before a rollover can occur.
There are three ways a spousal rollover can be accomplished. First, whether the inherited funds are coming from a qualified plan or an IRA a spousal beneficiary can direct the trustee/custodian to transfer plan/IRA assets directly to the trustee/custodian of a new or existing IRA titled in the name of the surviving spouse. There are no limitations to the number of tax-free trustee-to-trustee transfers allowed during a year. Second, whether the inherited funds are coming from a qualified plan or IRA the surviving spouse/beneficiary may withdraw the assets and transfer them to a new or existing IRA titled in the name of the surviving spouse as long as the transaction is completed within 60 days of the withdrawal.[3] Finally, a spousal rollover from an IRA may also be accomplished by treating the decedent’s account as his/her own, for example, by making contributions to it or by changing the IRA title from the decedent to the surviving spouse’s name.
Nonspouse beneficiaries can directly rollover an inherited account, however they only have the ability to retitle it as an inherited IRA in the name of the decedent for the benefit of the beneficiary. Unlike a spouse, a nonspouse beneficiary may not roll over an IRA or plan funds of a decedent into an IRA in his or her own name.[4] Like spousal rollovers, before a nonspousal rollover can be made, any RMD due must first be made. Following are the rules that must be followed for a nonspouse beneficiary to do a direct rollover to an inherited IRA account.
The rollover is accomplished by means of a direct transfer from the plan into an inherited IRA. Unlike a spousal rollover a 60-day rollover is not permitted. In fact, any distribution of the funds directly to the beneficiary instead of the inherited IRA will preclude the rollover. In addition, the inherited IRA must be a new IRA, not one already owned by the nonspouse beneficiary, and the IRA must be titled in the name of the decedent for the benefit of the beneficiary; for example, “Jane Doe, for the benefit of Bill Smith.” Furthermore, beneficiaries are not permitted to make additional contributions to the inherited IRA. Finally, the rollover must be completed by December 31 of the year following the account holder’s death. Once the rollover is made, if the beneficiary begins distributions by the December 31 of the year after the year of the decedent’s death, a payout over the beneficiary’s life expectancy is possible.[5]
Now that you have an understanding of the RMD payout options we can move our discussion to the beneficiary’s after-death RMD requirements. A chart of the below requirements is attached at the end.
After-Death RMD Where Spouse is Sole Beneficiary. Where the surviving spouse of the IRA owner/plan participant is the sole designated beneficiary he or she must choose whether to retain the account in the decedent’s name as an inherited IRA or roll the funds over to the surviving spouse’s own IRA (Spousal Rollover). This decision must be made regardless whether the participant dies before or after the required beginning date.
If the surviving spouse elects to do a spousal rollover, as indicated above, he or she can name a new beneficiary and take distributions on his or her own required beginning date. With this option RMDs are determined using the Uniform Lifetime Table of the surviving spouse recalculated annually. It should be noted that after the IRA is in the surviving spouse’s name, any distribution before he or she reaches age 59½ may trigger 10% early distribution penalty. If it appears the surviving spouse will need the funds prior to age 59½, the spouse may wish to maintain the account in the decedent’s name as an inherited account/IRA.
Alternatively, where the surviving spouse beneficiary maintains the IRA/account in the decedent’s name, if he or she wants to receive RMDs under the life expectancy payout option s/he must begin receiving distributions by the later of:
- December 31 of the year after the participant’s death
- December 31 of the year the decedent would have reached age 70½.
The payout is determined each year by dividing the account balance at the end of the prior year by the spouse’s life expectancy using the Single Life Table and recalculated in each year for which the distribution is required.
If the surviving spouse maintains the funds in an inherited IRA in the name of the decedent, but does not elect a lifetime payout by one of the dates above, depending on the default option provided in the plan document he or she will be required to either receive a lump sum distribution by December 31 of the year after the year of death or take distributions under one of following two rules:
- If the owner/participant died before his required beginning date, distributions will be subject to the 5-year rule.
- If the owner/participant died on or after his/her required beginning date, his/her remaining life expectancy is used as the required payout period. The life expectancy is determined using the Single Life Table using the participant’s age in the year in the year of death, minus one for each year that elapses thereafter.
A surviving spouse of a deceased participant may have an extended period before distributions are required. However, many qualified plans have a “default” payout rule that applies if the beneficiary fails to make rollover or life expectancy payout election prior to a date specified in the plan (such as five years after the decedent’s year of death). In such cases, a surviving spouse beneficiary who is sole beneficiary and has unlimited access to the funds may roll over a decedent’s qualified plan benefit.
The rollover can be made to the spouse’s own IRA or to an inherited IRA in the name of the decedent for the benefit of the surviving spouse, either of which is then subject to the respective requirements explained above.
For example, in a plan with a 5-year “default” payout, a surviving spouse who might otherwise be able to wait many years before taking any distributions would need to make a rollover of the account proceeds by the December 31 of the fourth calendar year after the decedent’s death. Otherwise, the entire remaining balance becomes a minimum required distribution in the fifth year and may not be rolled over. After the rollover is completed, the account is subject to the rules described previously.
After-Death RMD Where Nonspouse is Beneficiary. Where the individual who is the designated beneficiary is not a spouse the RMD options are as follows:
Regardless whether the participant dies before or after the required beginning date a nonspouse beneficiary has the right to make a life expectancy payout election. As previously discussed above:
- If this option is not available in the plan, the beneficiary will need to do a nonspousal rollover to an inherited IRA.
- The life expectancy election must be made by December 31 of the year after the year of the participant’s death.
- If a timely life expectancy payout election is made, the first minimum distribution is calculated by dividing the account balance as of December 31 of the prior year by the beneficiary’s life expectancy in the first year for which the distribution is being made, determined using the Single Life Table. For each subsequent year, the beneficiary’s life expectancy is adjusted by subtracting one from his or her prior year life expectancy.
If a nonspouse beneficiary does not make a timely life expectancy payout election, depending on the default option provided in the plan document he or she will be required to either receive a lump sum distribution by December 31 of the year after the year of death or take distributions under one of two rules:
- If the decedent died before his or her required beginning date, the 5-year rule applies.
- If the decedent died on or after his or her required beginning date, distributions must be made over the remaining life expectancy of the participant/decedent, determined using the factor from the Single Life Table for his or her age in the year in the year of death, minus one for each year that elapses thereafter. Each distribution must be made by December 31 beginning in the year after the year of the decedent’s death.
There are two special rules that apply if an IRA or plan account is payable to multiple beneficiaries. First, unless all of the beneficiaries are individuals as of the determination date (see no designated beneficiary below), none of the individuals are designated beneficiaries. Second, if there are multiple beneficiaries of an IRA or plan account, the payouts to all beneficiaries must be calculated using the life expectancy of the oldest beneficiary. This rule is unfavorable to younger beneficiaries because it forces them to take distributions more quickly than they would if their own life expectancy could be used. Fortunately, where there are multiple individuals as designated beneficiaries of an account, creating separate accounts for each beneficiary may permit each one to use his or her own life expectancy to calculate RMDs.
Creating separate accounts may permit each beneficiary to use his or her own life expectancy to calculate minimum distributions, provided certain requirements are met:
- The separate accounts must be established by December 31 of the year after the year of the decedent’s death;
- Gains, losses, contributions and forfeitures must be allocated to the separate accounts pro rata according to the proportionate share of each beneficiary; and
- Distributions must begin by December 31 of the year after the year of the decedent’s death.
Note that if multiple beneficiaries receive their shares through one trust, the establishment of separate accounts will NOT change the fact that the oldest beneficiary’s life expectancy is used to determine the payout period. Of course, if each beneficiary received his or her share through a separate trust, each could use his or her own life expectancy.
After-Death RMD Where No Designated Beneficiary. If the decedent has no “designated beneficiary,” (if one or more beneficiaries is an estate, charity, or nonqualifying trust) one of two rules applies:
- If the decedent died before his or her required beginning date, the entire account balance must be paid by the end of the fifth calendar year following the decedent’s death.
- If the decedent died on or after his or her required beginning date, distributions must be made over the remaining life expectancy of the participant/decedent, determined by using the Single Life Table for his or her age in the year in the year of death, minus one for each year thereafter.
There is one possible exception to the “no designated beneficiary” rules. In numerous private letter rulings, the IRS has permitted a spouse beneficiary to make a rollover of his or her interest despite lacking “designated beneficiary” status. However, these rulings are binding only on the individuals to whom they are issued
Life Insurance Strategies. While the five-year time limit on distributions of nonspouse IRAs/plan accounts is just a proposal, there is speculation that with the need to raise revenue in the future that the proposal could be enacted into law. To help address the current (as well as the future) income tax bill that will be incurred by IRA/plan account beneficiaries following are a couple of life insurance strategies worth considering.
Offset Beneficiary Income Taxes. Where your client’s retirement account beneficiaries are likely to be in a higher income tax bracket than the account owner, it may make sense to take larger withdrawals to help pay for a life insurance policy equal to the beneficiary’s projected income taxes. With this strategy, the beneficiary receives life insurance death benefits income tax-free and can use those funds to pay the taxes due on the inheritance. The type of policy (single life or survivorship) and the ownership structure will vary depending on the client’s specific situation.
Review Charitable Bequests. If you have a client that would like to make a bequest to a charity, it has long made sense for those individuals to leave their favorite non-profit their pre-tax IRAs. A charity can cash in a tax-qualified retirement asset such as an IRA at no income tax cost – and if there is a concern with estate taxes anything left to charity is excluded from estate taxation. This strategy can be taken one-step further to incorporate an heir. Like the above situation it may make sense to use the retirement distributions to help pay for a life insurance policy equal to the value of the retirement asset that will be left to the charity. With this strategy both the charity and heir receive income tax-free benefits.
In Summary. All IRAs and qualified plan accounts are subject to the after-death minimum distribution requirements. Beneficiaries wishing to extend payouts over their life expectancy (if permitted to do so) have important elections that must be made within specific time periods.
Single Life Table
(For Use by Beneficiaries)
| Age | Life Expectancy | Age | Life Expectancy | Age | Life Expectancy | Age | Life Expectancy |
| 0 | 82.4 | 29 | 54.3 | 58 | 27 | 87 | 6.7 |
| 1 | 81.6 | 30 | 53.3 | 59 | 26.1 | 88 | 6.3 |
| 2 | 80.6 | 31 | 52.4 | 60 | 25.2 | 89 | 5.9 |
| 3 | 79.7 | 32 | 51.4 | 61 | 24.4 | 90 | 5.5 |
| 4 | 78.7 | 33 | 50.4 | 62 | 23.5 | 91 | 5.2 |
| 5 | 77.7 | 34 | 49.4 | 63 | 22.7 | 92 | 4.9 |
| 6 | 76.7 | 35 | 48.5 | 64 | 21.8 | 93 | 4.6 |
| 7 | 75.8 | 36 | 47.5 | 65 | 21.0 | 94 | 4.3 |
| 8 | 74.8 | 37 | 46.5 | 66 | 20.2 | 95 | 4.1 |
| 9 | 73.8 | 38 | 45.6 | 67 | 19.4 | 96 | 3.8 |
| 10 | 72.8 | 39 | 44.6 | 68 | 18.6 | 97 | 3.6 |
| 11 | 71.8 | 40 | 43.6 | 69 | 17.8 | 98 | 3.4 |
| 12 | 70.8 | 41 | 42.7 | 70 | 17.0 | 99 | 3.1 |
| 13 | 69.9 | 42 | 41.7 | 71 | 16.3 | 100 | 2.9 |
| 14 | 68.9 | 43 | 40.7 | 72 | 15.5 |
Single Life Table
(For Use by Beneficiaries)
| Age | Life Expectancy | Age | Life Expectancy | Age | Life Expectancy | Age | Life Expectancy |
| 15 | 67.9 | 44 | 39.8 | 73 | 14.8 | 101 | 2.7 |
| 16 | 66.9 | 45 | 38.8 | 74 | 14.1 | 102 | 2.5 |
| 17 | 66.0 | 46 | 37.9 | 75 | 13.4 | 103 | 2.3 |
| 18 | 65.0 | 47 | 37.0 | 76 | 12.7 | 104 | 2.1 |
| 19 | 64.0 | 48 | 36.0 | 77 | 12.1 | 105 | 1.9 |
| 20 | 63.0 | 49 | 35.1 | 78 | 11.4 | 106 | 1.7 |
| 21 | 62.1 | 50 | 34.2 | 79 | 10.8 | 107 | 1.5 |
| 22 | 61.1 | 51 | 33.3 | 80 | 10.2 | 108 | 1.4 |
| 23 | 60.1 | 52 | 32.3 | 81 | 9.7 | 109 | 1.2 |
| 24 | 59.1 | 53 | 31.4 | 82 | 9.1 | 110 | 1.1 |
| 25 | 58.2 | 54 | 30.5 | 83 | 8.6 | 111 | 1 |
| 26 | 57.2 | 55 | 29.6 | 84 | 8.1 | ||
| 27 | 56.2 | 56 | 28.7 | 85 | 7.6 | ||
| 28 | 55.3 | 57 | 27.9 | 86 | 6.7 |
Paul August Alegi, CRC® is the head of Outside Sales and Business Development at ISC Financial Advisors, an SEC Registered Investment Advisor. He previously served as the Managing Partner at Contego Capital Advisors and its subsidiaries since 2009. Mr. Alegi has been in the asset management field for over 20 years and has held various sales and leadership positions with OppenheimerFunds, Transamerica, American Express, GE and ING.
Terri L. Getman, JD, CLU, ChFC, RICP, AEP (Distinguished) is the Business Development Director for Diversified Brokerage Services (DBS), one of the largest life brokerage general agencies in the United States. Prior to joining DBS Terri was Vice President, Advanced Markets at Prudential Insurance Company of America. In this role she was responsible for establishing the strategic direction of all marketing initiatives involving estate, business, executive benefits and retirement planning for Prudential’s life insurance company. Terri is a frequent contributor to insurance industry publications and speaker at national meetings on advanced life insurance topics.
The information presented is impersonal and not take into account the individual circumstances of the reader. Although the information in this article has been compiled from data considered to be reliable it cannot be guaranteed that the forgoing material is accurate, complete, or up to date. The charts and graphs contained herein should not serve as the sole determining factor for making investment decisions. A reader should not make personal financial or investment decisions based solely upon the information provided and this article should not be considered a substitute for a consultation with an investment adviser in a one-on-one context whereby all the facts of the attendee’s situation can be considered in its entirety and the investment adviser can provide individualized investment advice or a customized financial plan.
To the extent that you have any questions regarding the applicability of any specific issue discussed to your individual situation, you are encouraged to consult with an Investment Adviser.
All potential investors are encouraged to take time to research investment adviser firms, investment adviser representatives before establishing an investment advisory relationship.
ISC Financial Advisors and Diversified Brokerage Services are not related.
[1] Sometimes IRA owners and plan participants name a trust as beneficiary of their account, either to achieve estate planning objectives or for nontax reasons (e.g., the beneficiary is a minor child or another individual for whom outright ownership is not appropriate). If a trust is named as beneficiary, an individual receiving his or her interest through the trust can be a designated beneficiary if the trust meets four requirements:
- The trust is valid under state law.
- The trust is irrevocable or becomes irrevocable at death.
- The beneficiaries are identifiable from the trust instrument.
- A documentation requirement is met (this includes providing the trust document or a list of all the beneficiaries to the plan administrator or IRA custodian) by October 31 of the year after death.
[2] RMDs can be delayed until 4/1 of the year after the spouse reaches 70 1/2, then determined using the Uniform Lifetime Table of the spouse recalculated annually.
[3] Only one tax-free withdrawal is allowed from an IRA in a 12 month period IRC §408(d)(3)(B). There is a 20% withholding tax where the 60-day rollover is from a qualified plan.
[4] Prior to January 1. 2007, nonspouse beneficiaries of employer retirement plans, including qualified plans, tax-sheltered annuities, and eligible Section 457(b) governmental plans, were not permitted to roll over inherited funds to an IRA. However, in the Pension Protection Act of 2006, Congress included a provision designed to allow nonspouse beneficiaries of employer retirement plans to make a rollover of the plan interest to an inherited IRA. Initially these plans were not required to offer this direct rollover to nonspouse beneficiaries. Consequently, many nonspouse beneficiaries did not have access to these tax-free rollovers. Congress closed this gap in the Worker, Retiree and Employer Recovery Act of 2008 through a provision mandating employer-sponsored plans to offer the direct rollover option to nonspouse beneficiaries in plan years beginning after 12//31/2009.
[5] If the beneficiary does not begin distributions by December 31 of the year after the year of the decedent’s death, a rollover is still possible, but distributions will have to be made under the payout limits of the qualified plan (even after the funds are in the inherited IRA). A rollover under these circumstances may be helpful to make more investments available to the beneficiary, but it will not result in “stretching” the beneficiary’s payout period. See Notice 2007-7, 2007-5 IRB 395.