What Is a Not Designated Beneficiary?

A nonperson entity that inherits a retirement account is classified as a "not designated beneficiary"—often referred to as a nondesignated beneficiary—under the Setting Every Community Up for Retirement Enhancement (SECURE) Act for the purposes of required withdrawals. The SECURE Act passed in December 2019 and is effective for all inherited retirement accounts as of Jan. 1, 2020. 

Key Takeaways

  • A "not designated beneficiary" is a classification for certain nonperson entities who inherit a retirement account.
  • These nonperson entities are subject to different withdrawal rules than eligible designated beneficiaries or designated beneficiaries.
  • The timing of required withdrawals from an inherited account is based on whether or not the owner was already taking required minimum distributions.
  • A trust may be exempt from being a "not designated beneficiary" if it meets certain requirements of a "see through" trust.

How a Not Designated Beneficiary Works

Thanks to the SECURE Act, there are now three classifications of beneficiaries based on the individual's relationship to the original account owner, the beneficiary's age, and their status as either an individual or nonperson entity. The three classifications available for a person or entity that inherits a retirement account are: eligible designated beneficiary (EDB), designated beneficiary (DB), and "not designated beneficiary."

For the purposes of inherited retirement account withdrawal rules and requirements, a retirement account beneficiary that is a nonperson entity (such as an estate, trust, or charity) is considered to be a nondesignated beneficiary. These beneficiaries have no life expectancy of their own, as they are not living persons.

Requirements for Not Designated Beneficiaries

Estates, charities, and trusts (typically) are classified as not designated beneficiaries, as they are not individuals. Depending on the age of the retirement account owner at their date of death, the not designated beneficiary will be subject to one of two rules:

  1. Five-year rule: If the owner died prior to age 72, the required minimum distribution (RMD) age as of 2020, the five-year rule applies. The five-year rule stipulates that the beneficiary must take out the remaining balance of the retirement account over the five-year period following the owner’s death. There is no RMD in any one year, but the account must be fully depleted by Dec. 31 of the fifth year following the owner's date of death.
  2. Payout rule: If the owner died after age 72, the payout rule applies. This rule stipulates that the beneficiary may take out the remaining balance over what would have been the owner's remaining life expectancy had they not died. Under the payout rule, there is a set RMD that must be taken out each year. Of course, the beneficiary is allowed to take out more than the minimum required distributions. In the case of a charity (which does not have to pay income tax on inherited retirement assets), the beneficiary may choose to take all of the funds immediately. However, for beneficiaries subject to income tax, it makes more sense from a tax perspective to delay withdrawals as long as possible. Taking only the RMD allows the maximum funds to continue to grow tax-deferred.  

There are exceptions to the general nonperson entity rule for certain trusts that are set up as a direct flow-through to EDBs or DBs. In specific instances, the trust may be ignored for the purposes of identifying a beneficiary.

Exception for trusts with direct flow-through of assets

In the case of a trust, the trust beneficiaries, rather than the trust itself, are used to determine the classification of the beneficiary of an IRA. There are two main types of "see through" trusts to be aware of when identifying the trust's beneficiaries for classification purposes.

Conduit Trust
If the trust identifies a specific beneficiary or beneficiaries to receive all withdrawals from the IRA account, that individual or entity is treated as the direct beneficiary of the IRA. A conduit trust is unable to accumulate any funds prior to disbursing IRA withdrawals directly to its beneficiaries.

If the only beneficiary identified by the trust is an estate or charity (a nonperson entity), for example, the IRA is treated as having no designated beneficiary. On the other hand, if the beneficiary identified by the trust is an individual, the IRA is treated as having either an eligible designated beneficiary or a designated beneficiary, and the respective rules apply, depending on that individual’s classification and relationship to the decedent.

Accumulation Trust
Alternatively, if the trust has the ability to accumulate withdrawals from the IRA, rather than disbursing withdrawals in its entirety to the beneficiaries, it is considered an “accumulation trust.” This is the type of trust used to accumulate and disburse funds to its trust beneficiaries over time, as in a spendthrift protection situation.

Assume, for example, that a trust identifies the retirement account owner's four adult children as beneficiaries. However, the trust also states that the funds are to be disbursed to those adult children in amounts no more than $10,000 per person per year. Because the trust has power to accumulate the retirement account funds and disburse according to a pre-approved schedule, rather than disbursing freely to its identified beneficiaries, it is considered to be an accumulation trust. In this situation, the four adult children will be identified as the beneficiaries and the 10-year rule for DBs will go into effect.

However, because an accumulation trust usually identifies an estate or charity (a nonliving entity) as a beneficiary in some capacity, it is typically subject to either the five-year rule or the payout rule for not designated beneficiaries. Even if all funds are required to be distributed from the retirement account in a shorter time frame, the trust may accumulate and hold the assets according to the owner's pre-approved schedule. Accumulation trusts are harder to draft than conduit trusts, but a trust that can protect inherited assets longer may be a better choice for many retirement account owners.