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:
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.
RetirementIf a Roth IRA makes sense for you, here are ways to build the biggest nest egg possible with it.
InvestingWe share some lessons from friends and family on saving money and planning for retirement.
RetirementWe discuss the advantages of seeking professional help when it comes to managing our retirement account.
RetirementA traditional IRA gives you complete control over your contributions, and offers a nice complement to an employer-provided savings plan.
RetirementExplain how to use an IRA account to buy investment property.
RetirementFind out how your 401(k) works after you retire, including when you are required to begin taking distributions and the tax impact of your withdrawals.
RetirementEach retirement account will have a fee associated with it. The key is to lower these fees as much as possible to maximize your return.
ProfessionalsLearn how these must-watch movies for accountants teach about the importance of ethics in a world driven by greed and financial power.
RetirementLearn five tips that can help physicians get back on schedule in terms of making financial preparations they need to retire.
Investing BasicsUsing more than one financial advisor for money management has its pros and cons.
Most qualified retirement plans such as 401(k), 403(b) and SIMPLE 401(k) plans, as well as individual retirement accounts ... Read Full Answer >>
Most common retirement plans such as 401(k) and 403(b) plans, as well as individual retirement accounts (IRAs) allow you ... Read Full Answer >>
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 >>
All contributions to qualified retirement plans such as 401(k)s reduce taxable income, which lowers the total taxes owed. ... Read Full Answer >>
401(k) rollovers are generally not taxable as long as the money goes into another qualifying plan, an individual retirement ... Read Full Answer >>
Unlike regular employee deferrals, catch-up contributions are not included in the 415 limit. While there is an annual limit ... Read Full Answer >>