By Jeffery Levine, IRA Technical Expert
Follow Me on Twitter: @IRAGuru4EdSlott
There is often a lot of confusion when it comes to the post-death IRA distribution rules. Frequently, beneficiaries and/or their advisors believe they are subject to what is called the 5-year rule – meaning they have to empty the inherited account within 5 years after the date of death - when in fact, they may actually have much longer to do so. By “stretching” out distributions from the IRA over a longer period of time, there is a better chance of achieving tax-deferred growth and reducing a beneficiary’s tax burden. If you want to know whether you are subject to (or will be subject to) the 5-year rule, you need only ask yourself two questions. If the answer to either question is yes, than based on our tax laws, you are not (will not be) subject to the 5-year rule.
Question #1: Were you named directly on the beneficiary form?
Under the Tax Code, there’s a big difference between a beneficiary and a designated beneficiary. A designated beneficiary can only be a living, breathing person, while a beneficiary can be any entity, such as an estate or charity. If you (and presumably you are a living breathing person if you are reading this article!) are a designated beneficiary named directly on the beneficiary form of a deceased IRA owner, you will generally not have to empty the account within five years. Instead, you can set up a properly titled inherited IRA and take only the required minimum distributions (RMDs) out as calculated over your life expectancy. If you are a designated beneficiary, it doesn’t matter at what age the IRA owner died. If you were named on the beneficiary form, you can stretch the IRA.
By the way, your actual life expectancy and your “IRS life expectancy” are not the same thing. Although your personal health and well-being may differ drastically from someone else your age, for RMD purposes, you will both have the same IRS predetermined life expectancy.
Question #2: Did the IRA owner die after their Required Beginning Date?
If an IRA owner dies after their required beginning date (April 1 of the year following the year the IRA owner turns 70 ½), under rules set forth in the Tax Code, there is no longer a possibility of the 5-year rule being applicable. Instead, if there is no designated beneficiary, the non-designated beneficiary will be required to take minimum distributions from the inherited account using the deceased IRA owner’s remaining life expectancy. Depending on the IRA owner’s age at death, this could be as long as 15.3 years, or as short as just one year.
If however, the IRA owner died before their required beginning date, a non-designated beneficiary would fall subject to the 5-year rule.
In plain, clear, easy-to-understand English, the ONLY time the Tax Code requires an IRA to be emptied within five years is when the IRA owner dies before their required beginning date and there is no designated beneficiary. OK, so maybe it’s not so easy-to-understand after all, but hey, for the Tax Code, that’s about as clear as it gets.
Note: The rules described above are those outlined by the Tax Code. In some cases, an IRA custodial document could limit distributions further, so be sure to check with your custodian.