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Your Bank > Education and Advice > CNB University

Inheriting Retirement Plan Assets

J Terwilliger 2014
James P. Terwilliger, PhD, CFP® is Senior Vice President - Financial Planning Officer and can be reached at JTerwilliger@CNBank.com or (585) 419-0670 x50630.

As I often like to say, “How can something that should be so simple be so complicated”. But, it’s true when it comes to inheriting retirement plans.

The rules are many and confusing when managing the associated Required Minimum Distributions (RMDs). The penalty for violating such rules is severe – equal to 50% of the RMD amount.

Recently, Congress recently simplified part of the process by allowing employer retirement plans – 401(k)s, 403(b)s, and 457 plans – to be treated like IRAs when inherited. That is, all can be rolled over to inherited IRAs, spouses’ IRAs, or non-person entities.

The distribution options available to beneficiaries of retirement accounts depend on the age of the account owner at the time of death, the relationship (spouse or non-spouse) between the beneficiary and decedent, and whether the beneficiary is a person.

Age of the account owner.

If the decedent dies prior to his/her Required Beginning Date (RBD), the (living) beneficiary has two options for the newly-created inherited IRA: 1) start annual RMDs by December 31 in the year following death based on the beneficiary’s life expectancy as specified in the IRA Single Life Table, or 2) empty the inherited IRA by the end of the 5th year following the year of death. Two beneficiary exceptions will be described later – spouses and non-persons.

Recall that the RBD is April 1 of the year following the year in which the account owner reaches the age of 70-1/2. Most folks start RMDs the previous year in order to avoid two required distributions in the year of the RBD.

Note also that for someone working beyond age 70-1/2, if the worker is an active participant in the employer plan and the plan allows, the RBD is delayed and becomes April 1 in the year following retirement. So, it is possible for an employee considerably older than 70-1/2 to die before reaching his/her RBD for the employer plan. That does not hold for IRAs. Age 70-1/2 is the magic RBD age for traditional IRAs.

If the decedent dies after his/her RBD, the life-expectancy option is a bit different. Here the (living) beneficiary’s RMD payout period is the longer of the beneficiary’s or the decedent’s remaining life expectancy using the IRS Single Life Table.

Additionally, the decedent’s RMD must be distributed in the year of death. If it was distributed prior to death, fine. If not, the RMD must be taken and paid to the beneficiaries before the account can be rolled over to an inherited IRA. It is critical that this be accomplished by the end of that year. If not, an IRS penalty can be assessed. If the decedent died before reaching his/her RBD, no year-of-death distribution is required.

Relationship (spouse or non-spouse).

Spouse beneficiaries are allowed some additional flexibility.

First, a spouse may roll the plan over to his/her own IRA. Non-spouses do not have this option. The spouse’s age then determines the RBD for required minimum distributions. Of course, the spouse is then bound by the age 59-1/2 restriction regarding the ability to take distributions with or without penalty.

Second, a surviving spouse may roll the plan over to an inherited IRA. In this instance, the beneficiary spouse can delay taking RMDs until the decedent’s RBD if the decedent died prior to his/her RBD. This is an attractive option for young surviving spouses who want the flexibility to take distributions without penalty prior to age 59-1/2. Then at age 59-1/2, the spouse can simplify and consolidate by rolling the inherited IRA over to his/her own IRA.

Non-person beneficiary.

Such a beneficiary might be an estate, a charity, or non-qualified trust. (In this article, we will not consider a qualified or see-through trust for which there are clear beneficiaries who ultimately receive the inherited IRA RMDs. We will leave that topic for a future column.)

If the decedent died prior to his/her RBD, the non-person beneficiary can only use the five-year rule. If death occurred after the decedent’s RBD, RMDs follow the life-expectancy method, based on the decedent’s life expectancy, using the IRS Single Life Table. RMDs must begin no later than December 31 of the year following the decedent’s death.

Note that distributions exceeding the RMD are allowed at any time. The RMD is only a minimum. Inherited IRAs can be emptied at any time at any age without penalty.

Complicated, isn’t it?

The take-away message, however, is simple. If you are a beneficiary or an executor for an estate, be sure to work with a trusted, knowledgeable financial professional when managing RMDs for inherited IRAs. Contact us with any questions at 585-419-0670.

This material is provided for general information purposes only and is not a recommendation or solicitation to buy or sell any particular security, product or service. Past performance is not indicative of future investment results. Any investment involves potential risk, including potential loss of capital. Before making any investment decision, please consult your legal, tax and financial advisors. Non-deposit investment products are not bank deposits and are not insured or guaranteed by Canandaigua National Bank & Trust, or any federal or state government or agency and are subject to investment risks, including possible loss of principal amount invested.