All Things Financial Planning Blog

As your financial planner did an annual review of your financial plans, he or she probably went over your beneficiary designations to review whether or not everything was accurate and up to date. For many without planners, the last time they might have looked at beneficiary designations was when they enrolled in that workplace plan or opened an individual retirement account for themselves. If so, have things changed for you – when did you last review the beneficiaries of your accounts?

Let’s take a look at some of the beneficiary rules of retirement accounts and how those beneficiary designations impact our beneficiary’s distribution options and responsibilities where a lump sum or rapid depletion of the account might not be desired.

The Retirement Equity Act of 1984 requires that should any beneficiary named on a ‘qualified’ retirement account be that of someone other than the account holder’s spouse, the spouse would have to sign off on that beneficiary designation. Other than that you are free to name any beneficiary you wish or you could legally have no ‘designated beneficiary’.

Now before I move into beneficiary rules and distribution options you should be aware that there are tax laws and there are contract laws. Your retirement account has a custodial agreement which operates by contract law. So, I cannot stress this enough – be sure to read your custodial agreement to see what the contract beneficiary (default) rules are. You will want to understand, what would happen by operation of the agreement if you didn’t have a contingency beneficiary named, for example, and you and your spouse simultaneously lost your lives in a car accident and she was the primary beneficiary without a contingent named. Would the contract default rules not be what you would have liked to see happen with your retirement account? State laws might be the default. Check the custodial agreement just so you know.

Designated and No-Designated Beneficiary Distribution Requirements.

There are special rules where the retirement account owner failed to name a designated beneficiary, like naming an estate as beneficiary, for example. In this case, the rules differ depending upon whether the retirement account owner died before or after his or her ‘required beginning date’. The ‘required beginning date’ (the RBD) is April 1 of the year following the year in which the retirement account owner reaches age 70 ½ unless the decedent had continued to work and was not a ‘more-than-5%-owner’ of the business. For those who continue to work beyond age 70 ½, required minimum distributions (RMDs) can be delayed for qualified retirement accounts (such as 401(k), 403(b) accounts, etc.). This ability to delay does not apply to IRAs.

If you die after the RBD and have no designated beneficiary, then the distribution period is the retirement account owner’s life expectancy calculated in the year of death, reduced by one for each subsequent year. If the retirement owner dies before the RBD and there is no designated beneficiary, then the retirement account must be distributed within 5 years after death.

In all cases, whether there is a designated beneficiary must be determined by September 30 of the year after the retirement account owner’s death. If there is a a designated beneficiary, payouts from the account must begin no later than December 31st the year after death in order to keep open the ‘life expectancy option’. Failing to do so puts an IRA with a designated beneficiary into the five year rule meaning that the account must be liquidated no later than 12/31 five years after the year of death.

Beneficiaries who are individuals.

Spousal Beneficiaries. If you are a surviving spouse who is the sole beneficiary of your deceased spouse’s retirement account, you may elect to be treated as the owner and not as the beneficiary. If you elect to be treated as the owner, you determine the required minimum distribution (if any) as if you were the owner beginning with the year you elect or are deemed to be the owner. If you do not make that election and hold the account open in the decedent’s name, distributions must begin under the rules for the age of that deceased spouse. So, for example, if the deceased spouse was younger than the survivor, the survivor spouse might not want to roll over, or elect or deem, the account into his or her name because he or she would have to take distributions under the 70½ rule. If the monies were left in the younger decedent spouse’s IRA, they would not have to be distributed until that younger deceased spouse would have turned 70½. That would allow those monies that would then not have to be distributed earlier, the benefit of continued tax deferred growth!

Non-Spousal Beneficiaries. If you are an individual and a designated beneficiary figuring your first distribution, you would use your age as of your birthday in the year distributions must begin. This is usually the calendar year immediately following the calendar year of the owner’s death. After the first distribution year, reduce your life expectancy by one for each subsequent year.

Beneficiaries who are NOT individuals.

If the beneficiary is not an individual, you would have to determine the required minimum distribution for 2012 depending on when the death occurred in relation to the RBD.

Death on or after required beginning date. Divide the account balance at the end of 2011 by the appropriate life expectancy Table (Single Life Expectancy) in Appendix C of Publication 590. Use the life expectancy listed next to the owner’s age as of his or her birthday in the year of death, reduced by one for each year after the year of death.

Death before required beginning date. The entire account must be distributed by the end of the fifth year following the year of the owner’s death. No distribution is required for any year before that fifth year.

Concluding Comments.

As you might well imagine, this is just the tip of the iceberg in discussing retirement plan distribution rules. Do you have charitable intentions? Do you have a special needs individual that you want to provide for or protect? How might disclaiming a ‘beneficiary right’ to a retirement account benefit family planning? How does a Trust named as a beneficiary work?

Do yourself a favor … Get a Plan Check – Review your beneficiary choices and make sure they are in line with your testamentary intentions and needs!

David Bergmann, CFP®, EA, CLU, ChFC
Managing Principal
The David Bergmann Group
Marina Del Ray, CA