When an IRA owner dies, there are certain rules about how the money must be given out.
- Did the person who owned the IRA die before or after the "required beginning date"?
- Who will get the money?
In order to carry out the IRA owner's wishes, it is important to think about the practical and estate planning effects of the different choices the IRA owner makes during his or her life. When the IRA owner chooses a beneficiary, and if he or she is married, when the IRA owner dies, these are important decisions.
If you don't know the rules about the choices you can make, you're just shooting in the dark. If you make the wrong choice, it could cost you money and change how your IRA is paid out, which might not be what you want.
Let's make sure you understand how the game works.
The first part is the start date that must be met. This is April 1 of the year after you turn 70 and a half for traditional IRAs, SEPs, and SIMPLEs. Roth IRAs don't follow this rule because they have their own.
There are several large groups of people who will benefit:
- A beneficiary who is not a spouse.
- No one gets anything.
- The partner.
Let's look at each of these beneficiary choices and see how distributions are handled depending on whether the IRA owner dies before or after the required starting date.
The Wife or Husband as the Winner
If the spouse is the only person who gets money from the account, he or she can make a choice that affects when the payments must start. The option is to treat the owner's IRA as if it were their own.
Note: This option is not available if the IRA is given to a trust, even if the spouse is the only person who gets money from the trust. This problem might be solved by rolling over.
If the IRA owner dies before the required starting date, the spouse is the only beneficiary, and the election was made, the required distributions don't have to start until the IRA owner would have turned 70 and a half. If the IRA owner was younger, the spouse might choose to use this rule.
If the spouse chooses not to be treated as the owner, the required minimum distributions (RMD) start right away and are based on how long the spouse has left to live. When the spouse dies, the distributions keep going based on how long the spouse had left to live.
If the IRA owner dies after the required distribution date and the spouse does not make the election, the distribution must be made over the life expectancy of the spouse. However, the life expectancy of the IRA owner can be used if it is higher. The life expectancy is found by looking in a table at the age of the IRA owner when they died. Then you take one away each year. In this case, the point is that the spouse needs to compare each year to find the one with the longest pay out.
The "takeaway" is that knowing things helps you make good decisions. The best choice will depend on how old the IRA owner is when they pass away, how old their spouse is, how their health is, and whether or not they have children or grandchildren that they need money for.
Non-Spouse Recipient
If the IRA owner dies before the required start date, distributions must be made over the beneficiary's remaining life expectancy. If there are more than one, the oldest one is used.
Attention: Let's say the IRA owner is an 80-year-old widow. She names her 82-year-old sister and her 55-, 58-, and 60-year-old children as beneficiaries. Because she wants to help her sister, the IRA is paid out over the remaining life expectancy of an 82-year-old, which is probably a lot faster than she would have liked.
If the IRA owner dies after the required start date, the distributions must be spread out over whichever of the owner's or beneficiary's remaining life expectancies is longer.
No One Gains
If the IRA owner dies before the required start date, the money must be paid out over a period of five years.
If the IRA owner dies after the required distribution date, distributions continue for as long as the owner was expected to live.
I think you can see that there are several possible outcomes. When you add this to the fact that IRA distribution rules are complicated, it makes sense to sit down with your financial planner, tax attorney, and accountant to make sure that your IRA, SEP, or SIMPLE IRA fits in with your estate plan and that the most likely pattern of distribution matches what you want.
