In order for beneficiaries of retirement plan assets to take advantage of some of the options available to beneficiaries, they must take certain actions by specific deadlines. In this article we review these deadlines and their associated benefits. (For a review of the various options available to beneficiaries, see Distribution Rules For Retirement Plan Beneficiaries.)
Tutorial: Retirement Planning
December 31: Deadline to Avoid Penalties and Establish Separate Accounting
Avoiding Excess Accumulation Penalty
Beneficiaries who are required to distribute inherited retirement plan assets under the life-expectancy method must determine and distribute a minimum amount each year. These distributions must begin by December 31 of the year following the year the participant dies. Failure to distribute the required amount by this date will result in the beneficiary owing the IRS an excess accumulation penalty, which is 50% of the distribution amount not taken by the deadline.
If the participant dies before the required beginning date (RBD), the beneficiary may distribute the amounts over his or her life expectancy, either by election; or under five-year rule. If the life expectancy method applies and the beneficiary fails to distribute an RMD amount by December 31 during the first four years, the penalty will be waived if the total account balance is distributed by December 31 of the fifth year following the year of the account owner's death. In other words, the penalty will be waived if the beneficiary switches to the five-year rule. (For more insight, see When does the five-year rule apply?)
If there are multiple beneficiaries of a retirement account, distributions must generally occur over the life expectancy of the oldest beneficiary, if the assets are distributed under the life-expectancy method. This is not an issue for someone who is the oldest beneficiary. But for individuals who are considerably younger than the oldest beneficiary, this life-expectancy rule can be a financial-planning inconvenience since younger beneficiaries would forced to distribute much larger amounts than would be required had they been able to use their own life expectancies.
Regulations do, however, allow each beneficiary to use his or her own life expectancy if each allocates his or her portion to a separate account by December 31 of the year following the year the retirement account owner dies. The following example illustrates a possible difference in post-death RMD amounts.
Example - Differences in Post-RMD Death Amounts
John designated the following individuals as the primary beneficiaries of his IRA:
John died at age 75 in 2009. The beneficiaries must distribute the assets using the life expectancy option. The balance of the IRA as of December 31, 2009, is $900,000, which is to be shared equally.
As you can see, Tom and Harry are able to distribute smaller amounts and therefore owe less tax, have more flexibility with financial planning, and have a longer period over which to stretch the IRA payments.
Pre-Death Account Allocation: An Option for Separate Accounting
Before a retirement plan participant dies, he or she may help beneficiaries avoid being required to use the oldest person's life expectancy by establishing an account for each beneficiary. Each account would then have only one beneficiary.
October 31: Deadline to Provide Trust Instrument
Generally, the life expectancy option is not available to a non-person beneficiary, such as a trust, estate or a charity. However, an exception is allowed for qualified trusts. If a qualified trust is the beneficiary of the retirement account, then the life expectancy of the oldest underlying beneficiary of the trust may be used to determine RMD payments, including those to beneficiaries. A trust must meet certain requirements in order to be considered qualified. One important requirement is that the trust instrument must be provided to the IRA trustee, custodian or plan administrator by October 31 of the year following the year of the participant's death. (For related reading, see What are the requirements that a trust needs to meet to be qualified?)
September 30: Deadline to Determine Beneficiary
For the purposes of determining life expectancy factors, the designated beneficiary is determined on September 30 of the year following the year of the participant's death. This is very important for a retirement account with multiple beneficiaries, as beneficiaries remaining after September 30 may affect the stretch period or remaining life of the retirement account.
Say, for example, that a participant who died before the RBD named his two children and a charity as the beneficiaries of his retirement account. Because one of the beneficiaries has no life expectancy or is a non-person (the charity), the assets for all three beneficiaries must be distributed by December 31 of the fifth year following the year of the participant's death. However, this can be avoided if the charity distributes its portion of the assets by September 30 of the year following the participant's death. (For more information, see The Importance of September 30 for Multiple Beneficiaries of a Retirement Account.)
The Bottom Line
If you are a beneficiary of a retirement account, it is essential you are aware of the important dates outlined above. Adhering to these deadlines not only ensures that you take advantage of the benefits provided by RMD regulations, but also helps you to avoid penalties. Beneficiaries should consult with their financial consultants or tax professionals to ensure options are thoroughly explored and where there is a choice, that the most suitable one is selected.