In 1789, nearing the end of his extraordinary life, Benjamin Franklin wrote a letter to a dear friend and well-respected member of the French science community, Jean-Baptiste Le Roy. Over the centuries to come, this letter would become infamous for one line, “…but, in this world, nothing is certain except death and taxes.”
Franklin hit the proverbial nail on the head in saying that taxes will be certain, as we have now had over two centuries of American history solidifying Franklin’s assertion. Two centuries have made certain that not only are taxes inevitable, but the tax landscape is ever evolving and requires diligent planning to effectively adapt with it.
Beneficiaries
On December 20, 2019, the Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed into law by former President Trump. The SECURE Act was signed with the intent to improve retirement savings for individuals by loosening the restrictions on employer-sponsored retirement plans.
Furthermore, the SECURE Act, and later SECURE Act 2.0, further complicated the overall retirement planning landscape by adjusting the rules around distributions from inherited IRAs.
There are three types of beneficiaries:
Eligible Designated Beneficiary
An eligible designated beneficiary is:
- A surviving spouse
- A child of the decedent who has not reach the “age of majority” (meaning the child is still a minor)
- A “disabled or chronically ill individual”
- Any other individual who is less than ten years younger than the account holder
Designated Beneficiary
A designated beneficiary is any person who inherits an IRA or qualified plan who is not an eligible designated beneficiary.
Non-Designated Beneficiary
Non-designated beneficiaries are much less common and include the deceased account holder’s estate, charities, and certain trusts.
That is a lot of technical industry jargon, so, for the sake of clarity and simplicity, let’s focus on the two parties that we primarily see inherit retirement accounts: surviving spouses and/ or children of the decedent or Eligible Designated Beneficiaries.
Inheriting Spouses
Spouses who inherit an IRA are given more leeway than a non-spouse beneficiary with some variance in the different distribution options if the account holder (deceased spouse) reached their required minimum distribution age. If the deceased DID NOT reach RMD age, these are their choices:
Spousal rollover into an IRA
This is only a viable option if the surviving spouse is the sole beneficiary of the account. Under this method, the surviving spouse would become the account holder by rolling it into an existing or new traditional IRA in their own name.
In this instance, the account must follow all the rules that govern traditional IRAs.
Distribute over the deceased spouse’s life expectancy
RMDs for the surviving spouse are delayed until the deceased spouse would have reached RMD age (age 73 after 12/31/2022 and before 1/1/2033). Under SECURE 2.0, the surviving spouse is permitted to calculate RMDs using the Uniform Life Table rather than the Single Life Table, resulting in a larger factor, and therefore a lower required minimum distribution.
The Internal Revenue Service (IRS) developed “Life Expectancy Tables” that are used as a guide for retirees to determine their required minimum distribution each year.
There are three tables – Single Life Expectancy (Table I), Joint Life and Last Survivor Expectancy (Table II), and Uniform Lifetime (Table III) – that can be used depending upon the circumstances surrounding the account holder who is required by the IRS to take required minimum distributions.
This is beneficial when the surviving spouse is older than the deceased spouse. By electing to treat themselves as an original account holder, the surviving spouse can delay RMDs for a longer period; and, once RMDs are required to be taken, they will be smaller than if the surviving spouse had rolled the decedent’s account into their own or remained as a beneficiary of the account.
Example:
Joe is age 72 and has outlived his late wife Jane, who passed at age 68. Under this inheritance method, Joe can delay taking RMDs from Jane’s Traditional IRA for 5 years, when he will be age 77 (the year Jane would have turned 73).
Furthermore, Joe is permitted to use the Uniform Life Table (ULT), which currently has a factor of 26.5 at age 73, whereas the Single Life Table (SLT) has a factor of 16.4 (Assuming a $100,000 IRA, Joe’s required minimum distribution will be $3,773.58 using the ULT compared to $6,097.56 if he had been required touse the SLT).
10-year method
Under this method, the funds are transferred from the deceased spouse’s traditional IRA into a new inherited IRA in the name of the surviving spouse.
This method does not have a required distribution annually; rather, it requires that the assets be distributed by 12/31 of the 10th year after the account holder died.
Lump-sum distribution
The entire balance of the account is distributed to you. There are no penalties but there may be a large tax levy depending on the size of the inherited account.
If the deceased spouse DID reach RMD age before passing, the beneficiary is permitted to elect from the following choices:
- Spousal rollover into an IRA
- Distributing over the deceased spouse’s life expectancy
- Lump-sum distribution
It’s important to note if the deceased spouse DID reach RMD age, the surviving spouse is required to take the RMD by 12/31 of that year, if it has not yet been fulfilled.
Children Inheriting an IRA
Compared to the rules of a surviving spouse, the rules pertaining to inheriting children of the deceased account holder are rather straightforward. Assuming the inheriting child is a designated beneficiary – meaning they are not a “disabled or chronically ill individual” and are of the age of majority – they must distribute the plan assets within 10 years. The age of majority is the age at which a person gains the legal status of an adult. The age of majority is set by state law; nearly all U.S. states have set the age of majority at 18.
In this example, a beneficiary is eligible to take the distribution in a single, lump sum following the death of the account holder, or they may take the distributions over the allotted 10-year window. Currently, the IRS has not provided guidance as to whether RMDs will be required annually, but we expect to receive guidance on that before the end of 2024.
Disclosures
This article by Level Financial Advisors, Inc. (“Level”) is intended for general information and educational purposes only. No portion of the article serves as the receipt of, or as a substitute for, personalized investment advice from Level or any other investment professional of your choosing. Additionally, please note that guidance from the IRS on this topic is continuing to evolve and the relevant facts may change over time as the IRS rules and regulations change. Before acting on any information contained in this article, it may be necessary to consult with the appropriate professionals to receive individualized advice.
Level is neither a law firm nor accounting firm, and no portion of its services should be construed as legal, accounting, or tax advice. No portion of the content should be construed by a client or prospective client as a guarantee that he/she will experience a certain level of results if Level is engaged, or continues to be engaged, to provide investment advisory services.
A copy of Level’s current written disclosure brochure discussing our advisory services and fees is available upon request or at www.levelFA.com.
