Crossroads: Combining the Spousal Rollover Rules with the Separate Account Rules
By Jeremy T. Rodriguez, JD
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Tax rules can be confusing, and that can especially be the case when we are talking about the application of two separate rules. It’s easy to get confused when two or more tax laws intersect. For many, that occurs when we discuss the separate account rules for IRA beneficiaries along with the special rollover rules afforded to spousal beneficiaries.
If an IRA account has multiple beneficiaries, and that account is not split by December 31st of the year after death, then all beneficiaries are stuck using the life expectancy of the oldest amongst them. That treatment lasts until the account is emptied. For non-spouse beneficiaries, all post-death beneficiary Required Minimum Distributions (“RMDs”) must also begin by December 31st of the year after death. On the other hand, spousal beneficiaries can roll over inherited amounts to their own IRA accounts, essentially changing when RMDs begin. Spouses also get favorable treatment when calculating those RMDs. To illustrate, let’s take a fairly common example.
Jefferson dies in March of 2019 at 80 years old with a traditional IRA balance of $600,000. He names three beneficiaries: his wife Martha (65 yrs. old), his son Hamilton (39 yrs. old), and his daughter Caroline (36 yrs. old). Martha is to inherit 70% of the account (i.e., $420,000). Hamilton and Caroline will split the remaining amount, and each will inherit 15% of the account (i.e., $90,000 apiece). What deadlines must these beneficiaries meet?
- Jefferson’s 2019 Required Minimum Distribution (“RMD”): Since Jefferson died so early in the year, it’s unlikely that he took the full 2019 RMD. If he did, the beneficiaries don’t have to worry. However, if Jefferson did not then the year-of-death RMD must be distributed to the beneficiaries by the original due date (i.e., December 31, 2019). The RMD should be split according to the percentages each inherited.
- Splitting the Account: To use their own life expectancy for post-death beneficiary RMDs, Martha, Hamilton, and Caroline must split the account by December 31, 2020. Under these facts they can take one of two approaches:
- Split the account for each beneficiary. This is usually the best option because not only does each beneficiary get to use their own age when calculating
- Split the account in two; one for Martha and the other for Hamilton and Caroline. This approach may work since the big age disparity is between Martha and the two children. Hamilton and Carolina are only 3 years apart, so the difference in the RMDs is minimal. The beneficiaries could accomplish this by physically splitting the account in two or having Martha execute a spousal rollover of her portion to her own IRA.
What happens if the beneficiaries blow the deadline? What if two years go by before Martha talks with an advisor? This is where the rules intersect. The spousal rollover can be executed at any time. In this example, Martha would be 67 or 68 years old, depending on her birthdate and when she sought help. Regardless, she’s under 70 ½, which means she could execute the rollover and delay that year’s RMD.
It also means she wouldn’t have to take another RMD until she reached age 70 ½. At that point, she would use her own life expectancy to calculate RMDs.
But what about Hamilton and Caroline? Unfortunately, they aren’t so lucky. They can still split the account, which allows them chose their own investment lineup or even a different custodian if they transfer the account directly to another Inherited IRA. However, they are stuck using Martha’s life expectancy (according to the Single Life Table) for every post-death beneficiary RMD. To put that in context, that means for her first post-death RMD, Carolina is stuck using a life expectancy factor 20.2 (i.e., life expectancy factor for someone age 66), instead of using a life expectancy factor of 46.5 (i.e., factor for someone age 37).
The final loose end concerns the RMDs that were due for the two years that passed before any of these beneficiaries sought help. Since they didn’t split the account by December 31, 2020, an RMD was due for each of them using Martha’s life expectancy according the Single Life Table. Another RMD calculated under the same method was also due by December 31, 2020. Thus, not only are these beneficiaries taking RMDs using the highest life expectancy factor, but Martha is taking RMDs that she could have avoided! If those were taken, then everything is kosher. If not, then the missed RMDs must be distributed and are potentially subject to a 50% excise tax. Taxpayers can, however, request a waiver of the 50% penalty.
The death of a loved one is difficult, and in the aftermath of such an event tax rules are the last thing anyone wants to consider. The tax code takes that into account and pushes the deadline to the end of the year following death. However, you cannot ignore these issues forever. The consequences are far to grave.
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