Sept. 30: A Key Date for Retirement Plan Beneficiaries

If you recently inherited—or expect to inherit—retirement plan assets, you should keep Sept. 30 in mind. It's a very important date when it comes to retirement accounts with multiple beneficiaries. It's the deadline for determining whether an inherited individual retirement account (IRA) has a designated beneficiary or beneficiaries.

An IRA is considered to have a designated beneficiary if there are no "non-person" beneficiaries such as estates, trusts, and charities remaining as of Sept. 30 of the year following the account owner's death. A person who disclaims an inheritance prior to that date will not be considered when determining the designated beneficiaries of the IRA.

For example, a beneficiary who inherits an IRA in 2021 will have a determination deadline of Sept. 30, 2022.

As a result of the SECURE Act, there are now three classifications of beneficiaries: eligible designated beneficiary, designated beneficiary, and those not considered to be a beneficiary (from here on referred to as non-designated beneficiaries).

These are extremely important in determining the timing of required distributions out of the inherited IRA. In the case of multiple beneficiaries, the classification of all beneficiaries may change if one of the multiple beneficiaries takes certain actions by Sept. 30 of the year following the year the retirement account owner dies.

Another important date to keep in mind is Dec. 31. You may be required to take a required minimum distribution (RMD) as early as Dec. 31 of the year following the IRA owner's death, depending on your beneficiary classification and relationship to the account owner. 

If this applies to you, read on to find out how these rules work and how they might be applied to your situation.

Determining the Beneficiary Classification

If there is more than one beneficiary for a retirement account, the deadline of Sept. 30 is used to determine whether each one qualifies as a designated beneficiary. Before we look at multiple beneficiaries, we need to determine who qualifies in each of the three classifications.

An account is considered to have designated beneficiaries if all non-person (non-designated) beneficiaries take one of the following actions by Sept. 30:

• Take a full distribution of their portion of the inherited assets.
• Properly disclaim their portion of the inherited assets.

The beneficiaries that remain after this Sept. 30 deadline are the only ones taken into consideration when determining the beneficiary classification and timing of beneficiary distributions.

Illustrating the Rules

The following examples demonstrate the rules for the distribution options for multiple beneficiaries.

Example 1: Two beneficiaries, one a charity

John died this year at age 65, and the beneficiaries of his IRA—which is valued at $1 million—are his chosen charity and his 45-year-old son, Tim. Tim and the charity were each designated to receive 50% of the IRA.

Because John died before the required beginning date (RBD) and one of his beneficiaries is a non-person (the charity), the $1 million is subject to the five-year rule and must be fully distributed by Dec. 31 of the fifth year following the year John died.

Had his adult son Tim been the only beneficiary of the IRA, he would have been able to use the 10-year rule, in which case the funds would have to be fully distributed by Dec. 31 of the 10th year following the year John died.

But all is not lost for Tim. He may still be able to use the more tax-beneficial 10-year rule if the charity:

• Takes a full distribution of its half by Sept. 30 of the year following John's death, or,
• Properly disclaims its half by Sept. 30 of the year following John's death

Tim may ask the charity to take either of these actions so that he is allowed to benefit from using the more favorable tax rule.

Example 2: Account holder dies after RBD

The facts are the same as in Example 1 except that John dies at age 74. Because John died after the RBD and one of his primary beneficiaries is a non-person, post-death distributions must be taken over John's remaining life expectancy. These distributions must begin by Dec. 31 of the year following John's death. Let's assume John's remaining life expectancy was 13.4 years.

Again, if Tim had been the only beneficiary, he would be subject to the 10-year rule.

In this scenario, it may be more beneficial for Tim to take the distributions over his father's remaining life expectancy of 13.4 years. If the charity does not withdraw 100% of its half of the IRA ($500,000) by Sept. 30 of the year following John's death, both beneficiaries will be able to use John's remaining life expectancy. A savvy tax advisor may suggest the charity take 99% of its funds but leave 1% in order for both beneficiaries to continue qualifying as non-designated beneficiaries.

Example 3: Four family members as beneficiaries

Jake died this year at age 75, leaving his three children and his spouse, Mary, as his IRA beneficiaries. The ages of the children are 30, 32, and 35; none of them have a qualified disability or are chronically ill. Mary's age is 55.

Let's assume Mary's life expectancy is 35.2 years. She has the option to either continue to take Jake's RMDs over his remaining life expectancy (shorter than hers) or roll over the inherited funds to her own IRA and take RMDs when she would be required to begin taking her own.

Her thought process here may depend on whether she needs his RMDs at this point in her life because she is too young to take funds out of her own IRA without incurring the 10% early withdrawal penalty (age 59½). If she is able, it is more beneficial from a tax perspective to transfer the funds into her own IRA and use her own life expectancy. It lets the funds grow longer, and she will pay taxes on a smaller amount each year.

However, the three adult children are subject to the 10-year rule. They will be required to deplete their portion of the inheritance by Dec. 31 of the 10th year following the year Jake died. It does not matter how much they withdraw in any one year, so long as the full amount is removed from the account by that deadline.

Also, it is important to note that if an inherited traditional IRA is from anyone other than a deceased spouse, the beneficiary cannot treat it as his or her own. This means that a non-spousal beneficiary cannot make any contributions to the IRA or roll over any amounts into or out of the inherited IRA.

The Bottom Line

If you are one of the multiple beneficiaries of an inherited IRA, be sure to take the necessary steps to secure the best allowable distribution option.

If your distributions depend on what the other beneficiaries do by the Sept. 30 deadline, be aware that these other beneficiaries may not be willing to take a full distribution of their amounts because it may mean paying significant taxes for the year the distribution occurs. On the other hand, if their portions are insignificant amounts, or they are charities or other nonprofit organizations that do not pay income tax, they may be more accommodating.

Finally, be sure to consult with a tax professional before you make any decisions about your retirement assets, including those you inherit.