On June 14, 2004, the IRS issued regulations on the required minimum distributions (RMD) for defined benefit plans and annuity contracts providing benefits under qualified plans, individual retirement plans and section 403(b) contracts. If you're the beneficiary of a retirement account and the account-holder has died, you'll need to familiarize yourself with these rules. Here we take a look at how these rules work and what beneficiaries need to know.

Regulations As of 2002
Under the final RMD regulations issued in 2002, multiple beneficiaries of a defined contribution plan or IRA (collectively referred to hereinafter as "retirement account") are each allowed to use their own life expectancy to calculate post-death RMD amounts, if the assets are segregated into separate accounts by December 31 of the year following the year that the retirement account owner dies. However, each beneficiary's life expectancy can begin to be used only in the year after the year in which the separate accounting occurred. The following example illustrates the rule:

Example 1
John, who died in 2012, designated his three children, Jane, Sally and Sue as the beneficiaries of his IRA. Their ages in 2012 are 30, 40 and 50 respectively. They split the assets into three separate inherited IRAs in 2013. Because the assets were split into separate accounts by December 31, 2013, each beneficiary is allowed to use her own life expectancy to calculate post-death RMD amounts for her inherited IRA.
However, as the split occurred in 2013, the option for each beneficiary to use her own life expectancy is applicable only for years after 2013. Each beneficiary must therefore use the life expectancy of Sue, the oldest beneficiary, to calculate the RMD amount for 2013. If the split had occurred in 2012, each beneficiary would be able to use her own life expectancy in 2013.

Separate Accounting Rules Under the 2004 RMD Regulations
Under the RMD regulations issued in 2004, each beneficiary is allowed to use his or her own life expectancy for the year that follows the year the retirement account owner dies, if separate accounting occurs by December 31 of the same year.

Example 2

Here the facts are the same as in Example 1. Again, because the assets were split into separate accounts by December 31, 2013, each beneficiary is allowed to use her own life expectancy to calculate post-death RMD amounts for her inherited IRA. However, under the new rules, each beneficiary is allowed to begin using her own life expectancy in 2013, the year the split occurred.

This change in the rules will allow younger beneficiaries to distribute lower amounts for the year following the year of the retirement account owner's death.

Potential Financial Impact
This change could result in significant savings for the beneficiaries who are younger than the oldest beneficiary. Since their RMD amounts for the first year can be less, these younger beneficiaries might be able to claim a lower income for the year. The following example illustrates this point:

Example 3

Assume that the IRA that Jane, Sally and Sue inherited was worth $1 million as of December 31, 2012. Under the 2002 RMD regulations, the RMD for 2013 would be based on Sue\'s life expectancy of 34.2, resulting in a RMD amount of $9,747 for each beneficiary ($29,240/3). Under the 2004 regulations, each beneficiary\'s RMD amount for 2013 would be as follows:

Beneficiary Life Expectancy RMD Amount
Jane 53.3 $6,254
Sally 43.6 $7,645
Sue 34.2 $9,747

For Jane, the difference is $3,493 - a significant amount, especially considering the potential tax-deferred growth that would have been lost had she been required to distribute the higher amount.

The Reason Behind the Change
The IRS explained that it received several comments expressing concerns about the limited time available for accomplishing separate accounting, which is even more difficult if the retirement account owner dies late in the year. Consequently, many beneficiaries were not able to take advantage of the separate-accounting rules until the second year after the retirement account owner died. Under the newer rules, more beneficiaries are able to take advantage of the rules in the first year.

Accounting Requirement After Death
In order to take advantage of this provision, beneficiaries must share the gains and losses on post-death investments on a pro-rata basis until the date on which the separate accounts are actually established. This means that one beneficiary cannot lay claim to a particular investment and its related growth or loss. For instance, a beneficiary that inherits one-third of the account receives one-third of all the assets in the account.

Obviously, these RMD rules only affect multiple beneficiaries who are younger than the oldest beneficiary. If you are one of multiple beneficiaries, be sure to track losses and gains on investments after the IRA owner's death so that you can benefit.

Related Articles
  1. Retirement

    Roth IRAs Tutorial

    This comprehensive guide goes through what a Roth IRA is and how to set one up, contribute to it and withdraw from it.
  2. Retirement

    Retirees: How to Survive When Interest Rates Drop

    Low interest rates are a portfolio killer if you're living off of investment income. Some strategies for dealing.
  3. Term

    How Traditional IRAs Work

    A traditional IRA is a tax-advantaged retirement account that includes stocks, bonds, mutual funds and other investments.
  4. Retirement

    5 Reasons Millennials Lead in Saving for Retirement

    Say what you want to about millennials but the one thing they are doing better than any other generation is saving for retirement. Here's why.
  5. Retirement

    How Much Should You Have In Your 401(k) To Retire?

    Determining how much money should be in your 401(k) when you retire depends on several variables, many of which are uncertain.
  6. Economics

    Understanding Cost-Volume Profit Analysis

    Business managers use cost-volume profit analysis to gauge the profitability of their company’s products or services.
  7. Fundamental Analysis

    5 Must-Have Metrics For Value Investors

    Focusing on certain fundamental metrics is the best way for value investors to cash in gains. Here are the most important metrics to know.
  8. Investing

    How To Make Sure Your Healthcare Costs Do Not Ruin Your Retirement

    The best proactive plan of action for a stable retirement is to understand medical costs, plan ahead, invest properly, and consider supplemental insurance.
  9. Investing

    3 Small Steps to Maximize Your Investing Goals

    Instead of starting the New Year with ambitious resolutions, why not taking smaller manageable steps that can have a real impact.
  10. Investing

    7 Creative Ways to Save for an Early Retirement

    Take note of these out of the box steps you can take towards securing yourself an earlier, more comfortable retirement.
  1. Am I losing the right to collect spousal Social Security benefits before I collect ...

    The short answer is yes, if you haven't reached age 62 by December 31, 2015. The Bipartisan Budget Act of 2015 disrupted ... Read Full Answer >>
  2. Where else can I save for retirement after I max out my Roth IRA?

    With uncertainty about the sustainability of Social Security benefits for future retirees, a lot of responsibility for saving ... Read Full Answer >>
  3. When can catch-up contributions start?

    Most qualified retirement plans such as 401(k), 403(b) and SIMPLE 401(k) plans, as well as individual retirement accounts ... Read Full Answer >>
  4. Who can make catch-up contributions?

    Most common retirement plans such as 401(k) and 403(b) plans, as well as individual retirement accounts (IRAs) allow you ... Read Full Answer >>
  5. Can you have both a 401(k) and an IRA?

    Investors can have both a 401(k) and an individual retirement account (IRA) at the same time, and it is quite common to have ... Read Full Answer >>
  6. Are 401(k) contributions tax deductible?

    All contributions to qualified retirement plans such as 401(k)s reduce taxable income, which lowers the total taxes owed. ... Read Full Answer >>
Trading Center